Corporate Cash and Political Uncertainty

Abstract

How does political uncertainty affect firms’ saving? We incorporate election uncertainty into a dynamic model of firm investment and saving. Our model predicts that firms build up pre-election cash balances and, because cost of capital is high when uncertainty is high, begin to rely on this cash before elections resolve uncertainty. We find strong support for our predictions in our data and show that firms save an extra quarter’s worth of cash before elections. This saving reflects substantial heterogeneity in firms’ available sources of funding, so that changes to no one source of cash explains firms’ aggregate pre-election saving. Firms that can cheaply raise internal funds by, for example, retaining cash flow or decreasing payout do so. Other firms that rely on external equity markets to raise cash adjust the timing and magnitude of issuances to avoid higher financing costs around elections. Their willingness to rely on expensive equity issuance before elections is evidence of the importance of political uncertainty to firms’ saving decisions.

Keywords: corporate saving, cash, political uncertainty, gubernatorial elections, economic policy uncertainty

JEL Classification: D72, G31, E21