Political Uncertainty and Corporate Investment

Abstract

We document novel evidence that political uncertainty has a dampening effect on corporate investment. Specifically, we find significant cycles in firm-level corporate investment corresponding with the timing of national elections across a sample of 48 countries between 1980 and 2004. During the year leading up to the election outcome, firms reduce investment expenditures by an average of 5.3%relative to non-election years, controlling for firm characteristics and economic conditions. We investigate several potential explanations and find evidence consistent with the hypothesis that political uncertainty generates cycles in investment expenditures in election years. In particular, we find that the investment cycles are more pronounced in countries with fewer checks and balances in place at election time, parliamentary political systems, civil law legal origins, and among countries with higher measures of economic risk. Within countries, the cycles are more pronounced for firms in politically sensitive industries, firms with high capital intensity, and firms with a lower proportion of sales coming from exports. We also find that investment cycles are stronger around elections with more uncertain outcomes as measured by the closeness of election result. Decreases in corporate investment correspond with temporary increases in corporate cash holdings in the year leading up to the election. Overall, these findings suggest that political uncertainty is an important determinant of corporate financial policies around the world.