Political Ties and Predictable Returns

Abstract

This paper demonstrates the importance of inter-firm political links, measured by common campaign contributions made by firm executives. Price movements of a firm’s stock are predictable based on stock price movements of connected firms. Cross-predictability is strongest among politically connected firms that operate in different states and sectors, suggesting that inter-firm political links are largely overlooked due to limited investor attention. To probe the underlying mechanism, I present evidence suggesting that common sources of political exposure across firms ex-ante cannot alone explain this relationship; instead, political ties play the key role, further synchronizing ex-post political agendas. Using the 2010 Citizens United v. FEC decision as an exogenous shock, I find that cross-predictability is weaker for firms that are restricted from actively engaging in political campaigns. Long-short stock portfolios based on political ties yield risk-adjusted returns of 4%-5% per annum.