Asset Pricing Implications of Firms’ Government Sales Dependency

Abstract

AbstractThis paper investigates the firm-level, asset pricing implications of government expenditures. Higher government sales dependency (GD), unconditional on political partisanship cycles, significantly predicts positive future returns, and a GD-weighted portfolio substantially improves the tangency portfolio’s ex post Sharpe ratio. Conditionally, the results are stronger during Republican presidencies. Higher returns do not stem from political connections or political and regulatory risks. The underlying economic channel is higher expected cash flow from increased profitability. Atypical provisions of government contracts and information asymmetry likely drive higher profit margins. A risk versus a mispricing analysis elicits more convincing evidence for mispricing as an explanation for abnormal returns. (JEL G18, G38, H50, H57, H72)Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.