Boards Should Scrutinize Political Spending

Meaningful and effective oversight by directors of company contributions can help avoid investigations, fines, and indictments

Until recently, directors have paid scant attention to company political spending. Because the amount corporations devote to politics is quite small and might seem immaterial, especially as a proportion of company revenue, it often hasn't been disclosed.

The fact that political spending is highly regulated by laws at the state and federal level should make oversight of it de rigueur. Companies and their employees face the threat of investigation, indictment, and hefty fines for violating campaign finance laws.

However the absence of scrutiny has exposed companies to substantial legal and reputation risks that, at times, have turned out to be costly. This makes it imperative that directors oversee how companies use their money politically.

Consider the following: The chairman and a top executive of Vesco pleaded guilty in May, 2007, to political corruption charges that included illegal campaign contributions. The Alaska-based multinational oil services company itself faces potential criminal liability.

Freddie Mac (FRE) paid a record $3.8 million fine to the Federal Election Commission in 2006 to settle charges it illegally used corporate resources for congressional fundraisers. It's also embroiled in civil litigation stemming from these violations.

Closed-Door Decisions

Time magazine (TWX) faulted Merck (MRK) in mid-2006 for a contribution to a state supreme court candidate "who ran on an anti-gay-marriage platform and in a TV ad boasted to a white audience of his status as 'one of us'" while the company touted its policies promoting diversity, and provided health insurance to same-sex partners. According to Time, Merck, which declined comment, began disclosing contributions in 2005, but its board wasn't supervising the company's giving.

Companies encounter these problems because many make political-spending decisions behind closed doors, don't fully evaluate the risks associated with—and the impact of—the expenditures on their reputation, and leave the decisions to lower-level, government-relations staff. These problems apply most notably to soft-money political donations made with corporate funds or payments to trade associations and other nonprofit groups such as 501(c)(4)s that are used for political purposes.

This situation is changing as prosecutors more closely scrutinize political donations, executives feel increasingly uncomfortable about pressure to contribute, and shareholders and proxy-voting advisory services insist that companies practice political transparency and accountability.

Today 43 leading public companies, including Hewlett Packard (HPQ), American Electric Power (AEP), Pfizer (PFE), Aetna (AET), and DuPont, have adopted policies requiring disclosure and board oversight of political spending that uses corporate funds. More companies are expected to join them shortly.

Meaningful and Effective Oversight

All of this is making political disclosure a corporate governance standard. It's also placing political spending squarely on the directors' agenda.

Just what does oversight of company political spending entail and how should it be conducted? How can directors be sure their oversight is meaningful and effective?

A recent Mason-Dixon Polling & Research survey of directors highlighted a serious obstacle: the wide gap between directors' professed and actual knowledge of campaign finance laws and disclosure requirements. According to the poll, 75% said they were familiar with the laws.

On closer questioning, however, 88% didn't know companies weren't required to disclose all their political spending, 87% didn't know trade associations weren't required to disclose the names of their members and the beneficiaries of their political spending, and 77% didn't know that 501(c)(4) organizations, a new conduit for political spending, weren't required to disclose their contributors or beneficiaries of their spending. (Commissioned by the Center for Political Accountability, the poll was based on interviews with 255 directors between Feb. 4 and Feb. 15, 2008, and has a margin of error of plus or minus six percentage points.

Beyond the Bottom Line

Nevertheless, the poll shows directors recognize that corporate political spending carries real risks and they support disclosure and board oversight of it. Two-thirds said recent corporate scandals involving political activities have "damaged the public's confidence and trust in Corporate America," and a similar majority (60%) agreed reforms were necessary to "protect companies from risk."

Directors should follow the advice issued in 2007 by the Conference Board, a leading business organization, to "actively think about" and "to creatively address" the governance issues, including political transparency and accountability, that arise. Clearly, political spending decisions have ramifications beyond the bottom line and require a longer view and safeguards to help resist unwelcome demands and threats by elected officials.

With regard to political spending, that means creating a culture that promotes ethical and responsible behavior. Directors should insist that their companies adopt a strong code of conduct for political spending. The code should be designed to take into account the risks, both legal and reputational. It should also be transparent and provide for wide participation in decision-making. Without a strong code the company is poorly positioned to resist the inevitable pressures from importuning candidates.

Guided by Informed Intuition

Directors also must examine their company's political spending via trade associations and other organizations to ensure it doesn't conflict with the company's publicly stated positions and values. Finally, they need to know, and take responsibility for, where their company's political money ends up.

Serious oversight goes beyond policies and procedures. Directors must be guided by what we call informed intuition, what University of Denver law professor Stephen Pepper defines as conscience, courage, and candor. "[M]oral intuition, honesty with yourself about that intuition, and self-confidence in regard to what you're seeing…can make a big difference," he states.

In the end, it is directors who must insist their companies not only be accountable, but also be responsible participants in the democratic process. Knowledgeable, critical, and independent oversight of their companies' political spending is central to doing that.

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