Political Business Cycles, Elections and Entrepreneurial Finance: A Framework

Abstract

Political processes affect the real economy. An important channel through which politics affects economics is uncertainty. It has been observed that political uncertainty is high around national elections and negatively affects corporate investments and foreign capital inflows. If national elections affect corporations and foreign investors, we should expect them to also affect entrepreneurial finance provided by investors like venture capitalists (VCs). To add to that, in a complex federal democracy, state level politics is a significant source of political uncertainty. This is the first paper to examine the impact of national and state elections on entrepreneurial finance and provides a framework of VC investment behavior in the face of political uncertainty. We find that VC investments decrease significantly due to political uncertainty around national and state elections. VCs respond strongly to national elections by decreasing the total investment value and the number of deals in election years. However, they give a softer response to regional political uncertainty around state elections by decreasing only the average deal size. The findings have important implications for governments, regulators and policymakers, and open up an opportunity to examine a variety of new questions which can provide a more detailed and nuanced understanding of the impact of elections on VC investments.