Abstract
We demonstrate that legislation has a simple, yet previously undetected, impact on stock prices. Exploiting the voting record of legislators whose constituents are the affected industries, we show that the votes of these “interested” legislators capture important information seemingly ignored by the market. A long-short portfolio based on these legislators' views earns abnormal returns of over 90 basis points per month following the passage of legislation. Industries that we classify as beneficiaries of legislation experience significantly more positive earnings surprises and positive analyst revisions in the months following passage of the bill, as well as significantly higher future sales and profitability. We show that the more complex the legislation, the more difficulty the market has in assessing the impact of these bills. Further, the more concentrated the legislator's interest in the industry, the more informative are her votes for future returns.
Highlights
An important but understudied relationship that impacts firms is the one between firms and the government
We show that a long-short portfolio of industry returns in the month following the passage of a bill where we listen solely to vested interest legislators, yields returns of 76 basis points per month
Using the number of times a bill is voted on as a measure of bill complexity, we show that the spread portfolio on complex bills earns large positive abnormal returns (ranging from 85 basis points in raw returns (t=2.19) to 90 basis points (t=2.28) in four-factor alphas), while the set of non-complex bills is associated with much smaller return predictability, consistent with the idea that the market has more difficulty processing the likely impact of complicated pieces of legislation as opposed to more routine bills
Summary
Our paper adds to a vast literature that studies the impact of government policies on firms. While a large literature studies the impact of government actions (e.g., spending policies) on broader state-level outcomes (see, for example Clemens and Miran (2010), Chodorow-Reich, et al (2010), Wilson (2011), Fishback and Kachanovskaya (2010), Serrato and Wingender (2011) and Shoag (2011)), our approach in this paper is closest to a recent strand of the literature that explores firm-level outcomes. Our focus in this paper is on all Congressional legislation, not budget bills or spending polices, and our outcome variable of interest is the stock returns of affected firms In this sense, our paper is related to a recent literature examining the impact of government policy on asset prices (Pastor and Veronesi (2012), Belo, Gala, and Li (2012)). Since our interested and uninterested legislator groups change for each bill depending solely on industry, this forms finely specified treatment and control groups that allow us to control for other voting determinants, and identify solely this vested interest impact on each vote
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