Does Corporate Diversification Retrench the Effects of Firm-Level Political Risk?
59 Pages Posted: 10 Jul 2020 Last revised: 2 Apr 2021
Date Written: June 17, 2020
This study investigates the effects of firm-level political risk on corporate investments and operating efficiencies for industrially diversified and focused firms. Using firm-level political risk data from Hassan et al.(2019), we document that both political risk and diversification lead to reduced corporate investments and profitability. However, diversified firms are better able than focused firms in mitigating idiosyncratic political risk. We provide extensive evidence that diversified firms accomplish this feat via efficient use of the internal capital market that allows segments to alleviate the adverse effects of political uncertainty. Diversification increases investment relative to focused firms during the period of high economic uncertainties. When exposed to political risk, diversified firms do not spend more on lobbying and political donations than the focused firms in the subsequent period, implying that diversified firms do not manage political risk politically. Our main findings are robust to a battery of endogeneity tests and sensitivity measures.
Keywords: Diversification, Political Risk, Corporate Investments, Profitability, Internal Capital, Political Donation
JEL Classification: E22, E24, E32, E6, G31, G32, G38, H32
Suggested Citation: Suggested Citation