Political Preferences and Financial Market Equilibrium

Abstract

We present a model with conflicting political preferences among investors. We show that heterogeneous political preferences endogenously lead to polarized corporate political stances and partisanship in portfolio holdings. Expected stock returns of partisan firms are lower than those of politically neutral firms in a competitive equilibrium, and the return gap is amplified if corporate partisanship reduces expected cash flows, and mitigated if centrist investors grow in influence. While value-maximizing corporate political stances maximize aggregate welfare under certain conditions, they impose disutilities on dissenting investors and are susceptible to influence by a politically active large investor. If the cost of such influence activity is low, protecting small shareholders by requiring corporate political stance to match the ownership- weighted average of shareholder preferences can increase aggregate welfare.

Keywords: Corporate political stance, political polarization, partisanship, corporate governance, non-pecuniary utility

JEL Classification: G10, G11, G12, G30, G32, G34