An analysis of political uncertainty and corporate investment cycles in Pakistan

Abstract

This paper documents the cycles in corporate investments around national elections in Pakistan from 2000 to 2016. It employed the investment-Q model as the baseline specification with firm fixed effects. Results revealed that during election years, firms tend to reduce investment expenditures as compared to a period having no election after controlling for firm characteristics and economic condition. The study also witnessed pre-election manipulation and the presence of the political business cycle in Pakistan in the period leading up to the national election. This study witnessed variations in the impact of political uncertainty across elections and found more pronounced investment cycle for close contested elections. It also revealed negative changes in investments around national elections for market-friendly and lagged investments; however, results of sensitive industries were insignificant for Pakistan. Furthermore, empirical findings reveal that cashflows levels are consistent with the cautionary effect predicted by the real options theory which proposes that firms hold more cash in the period of high political uncertainty and wait until the uncertainty regarding political uncertainty is resolved. The results of this paper suggest that there should be a consensus between political parties on key economic policies so that even with the change of government; the key policies should remain the same.