Hedging on the Hill: Does Political Hedging Reduce Firm Risk?

Management Science, Forthcoming

57 Pages Posted: 6 Jan 2021

See all articles by Dane M. Christensen

Dane M. Christensen

University of Oregon

Hengda Jin

University of Utah - David Eccles School of Business

Suhas A. Sridharan

Emory University - Goizueta Business School

Laura Wellman

Pennsylvania State University; Pennsylvania State University - Department of Accounting; Penn State University

Date Written: December 28, 2020

Abstract

We examine whether firms’ political hedging activities are effective at mitigating political risk. Focusing on the risk induced by partisan politics, we measure political hedging as the degree to which firms’ political connections are balanced across Republican and Democratic candidates. We find that greater political hedging is associated with reduced stock return volatility, particularly during periods of higher policy uncertainty. Similarly, greater political hedging is associated with reduced crash risk, investment volatility, and earnings volatility. Moreover, the reduction in earnings volatility appears to relate to both a firm’s taxes and its operating activities, as we find that greater political hedging is associated with reduced cash effective tax rate volatility and pretax income volatility. We further find investors are better able to anticipate future earnings for firms that engage in political hedging, suggesting that political hedging helps improve firms’ information environments. Lastly, we perform an event study using President Obama’s Clean Power Plan. We find that on the days this policy proposal was debated in Congress, energy and utility firms experience heightened intra-day return volatility (relative to other firms and non-event days). However, this heightened volatility is mitigated for energy and utility firms that are more politically hedged. Overall, we conclude that political hedging is an effective risk management tool that helps mitigate firm risk.

Keywords: Political connections; Hedging; Stock return volatility; Earnings volatility; Firm risk; Risk management

JEL Classification: G32

Suggested Citation

Christensen, Dane M. and Jin, Hengda and Sridharan, Suhas A. and Wellman, Laura, Hedging on the Hill: Does Political Hedging Reduce Firm Risk? (December 28, 2020). Management Science, Forthcoming, Available at SSRN: https://ssrn.com/abstract=3756443

Dane M. Christensen

University of Oregon ( email )

1280 University of Oregon
Eugene, OR 97403
United States

Hengda Jin

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

Suhas A. Sridharan (Contact Author)

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States

Laura Wellman

Pennsylvania State University ( email )

378 Business Building
University Park, PA 16802
United States
6026225683 (Phone)

Pennsylvania State University - Department of Accounting ( email )

University Park, PA 16802-3306
United States

Penn State University ( email )

University Park, PA 16802-3306
United States

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