Navigating Policy Uncertainty: Politically Experienced Directors and Corporate Investment

Abstract

Previous studies show that economic policy uncertainty has been rising steadily since the 1960s (Baker et al. 2014), and that this secular increase has led to harmful economic outcomes such as reduced investment rates (Gulen and Ion 2016). Other studies find that politically connected directors play a unique role in corporate decision making and firm valuation (Goldman, Rocholl, and So 2009). We combine these two lines of research to examine the ability of politically experienced directors (PEDs) to mitigate the harmful investment effects of policy uncertainty. Our results show that the presence of at least one PED on a company board reduces the sensitivity of investment decisions to policy uncertainty by 49% relative to firms without PEDs. We design endogeneity tests in accordance with theoretical predictions and our results remain robust. Overall, our findings confirm that PEDs can significantly reduce the harmful effects of policy uncertainty, consistent with Pastor and Veronesi’s (2013) political risk premium theory and Dixit and Pindyck’s (1994) real options theory.

Keywords: Policy uncertainty, Directors, Political experience, Investment