Precious Neighbors: The Value of Co-Locating with the Government
Jörg R Stahl
Review of Finance, Volume 27, Issue 4, July 2023, Pages 1269–1296, https://doi.org/10.1093/rof/rfac063
Firm headquarters are overwhelmingly concentrated in capital cities, more so than the rest of economic activity. Several factors could explain why co-locating with the government is attractive for firms. Spatial proximity to politicians facilitates political influence and motivates agents to be active in capital cities. In addition, capital cities’ high-quality infrastructure and high levels of amenities attract talent to the city, which increases firms’ investment opportunities. This suggests that locating next to the government can be of substantial value.
However, most capital cities are also very large. The high concentration of firm headquarters may simply be explained by firms’ preferences to locate in large metropolitan areas and benefit from agglomeration economies. Since in most countries the capital city is the largest city, the value effects of firms’ co-locating with the government are normally hard to identify. Approaches that estimate cross-sectional regressions between cities or that examine headquarters relocations typically raise endogeneity concerns.
This paper applies a different approach by analyzing the move of the government from one city to another. It studies the decision to relocate the German federal government from Bonn to Berlin in 1991 and corresponding effects on firms. The course of events surrounding the German reunification allows to isolate the effects of the relocation decision from the impact of other events. In addition, even days before the crucial vote on the relocation, its outcome was highly uncertain. The vote was very close (338 to 320 votes in favor of Berlin), and it was preceded by an almost 13 hour long debate in the parliament, with a multitude of speeches by proponents of either of the two cities. Importantly, parties allowed their MPs a free vote, making it near-impossible to predict the outcome.
To analyze the value effects from co-locating with the government, I apply an event study analysis and quantify the abnormal changes in firm capitalization at the time of the decision. Firms with headquarters in Berlin experience mean cumulative abnormal returns of more than 3 percent within the three trading days surrounding the decision. Suggestive evidence shows that especially firms in skill-intensive and lobbying industries benefit from co-locating with the government.
The paper shows that it is valuable for firms to locate next to the government. The results contribute to our understanding of the drivers of the high concentration of economic activity in capital cities. They also add geographical proximity to a country’s most powerful policymakers as an important factor for headquarters location decisions.