The budgets of wars: Analysis of the U.S. defense stocks in the Post-Cold War era

Abstract

In this study, we consider the effects of the U.S military participation in direct and indirect foreign conflicts, defense budget announcements, and various political factors have on the abnormal returns to five largest U.S. defense companies’ share prices. We conducted this analysis by using a fixed effect panel approach along with event studies, using quarterly data over 30 years, from 1990 through the end of 2019. Our findings contribute to the largely dated and highly fragmented literature on the geopolitical drivers of the MIC (military-industrial complex) shares performance. We find that, in contrast to the established literature, defense budgets announcements have complex and dynamic statistically significant positive impacts on defense company stock performance through current period budget announcements, changes to the prior budget announcements and lagged budget announcements. We also find that a single party control over the House of Representatives and the Senate has no significant impact on abnormal returns, whereas solely having a Republican President in office acts as a significant catalyst for excess returns to MIC stocks when compared to the Democratic Party Presidencies. Consistent with potential for overshooting expectations by investors, direct conflict participation has a significantly positive impact on stock performance. This effect is almost fully moderated by the subsequent period negative reaction. Overall, our evidence suggests that defense companies perform better in those periods with greater likelihood of unexpected conflict-related news, greater geopolitical volatility, less informationally efficient markets, and the potential for conflict escalation. To the best of our knowledge, this is the first study of determinants of abnormal returns to MIC stocks that takes explicit account of the nature of U.S. participation in a military conflict (direct vs indirect), while controlling for an exhaustive range of complex budgetary and political factors and lags.