The Real Effects of Checks and Balances: Policy Uncertainty and Corporate Investment

77 Pages Posted: 1 Nov 2019

Date Written: October 1, 2019

Abstract

This article explores the economic effects of checks and balances on corporate investment and employment. I use U.S. gubernatorial election results from 1978 to 2010 as a source of exogenous variation in whether the party controls both the executive and the legislative branch (unified government) or not (divided government), which determines its ability to implement its political agenda. I find that both public and private firms respond to the political cycle by reducing investment and hiring when government becomes unified. Investment drops by three to five percent in the year following an election resulting in unified government, while stock returns volatility is three percent higher. The findings support the hypothesis that moving from divided to unified government raises policy uncertainty by increasing the probability of future policy changes. Consistent with a real option channel, the effect is stronger for capital intensive firms with lower asset redeployability.

Keywords: Investment, Checks and balances, Divided government, Gubernatorial elections, Political uncertainty

JEL Classification: E22; E66; G18; G31; G38; H75

Suggested Citation

Duquerroy, Anne, The Real Effects of Checks and Balances: Policy Uncertainty and Corporate Investment (October 1, 2019). Available at SSRN: https://ssrn.com/abstract=3477792

Anne Duquerroy (Contact Author)

Banque de France ( email )

Paris
France

Register to save articles to
your library

Register

Paper statistics

Downloads
9
Abstract Views
90
PlumX Metrics