Journal of Financial Economics 124 (2017) 563–579

Contents lists available at ScienceDirect

Journal of Financial Economics

journal homepage: www.elsevier.com/locate/jfec

Political uncertainty and investment: Causal evidence from

U.S. gubernatorial electionsR
Candace E. Jens
Tulane University, A. B. Freeman School of Business, Goldring/Woldenberg Hall II, 7 McAlister Dr, M132, New Orleans, LA 70118,
United States

a r t i c l e i n f o a b s t r a c t

Article history: I examine the link between political uncertainty and firm investment using U.S. guber-
Received 15 October 2013 natorial elections as a source of plausibly exogenous variation in uncertainty. Investment
Revised 30 June 2015
declines 5% before all elections and up to 15% for subsamples of firms particularly suscep-
Accepted 18 January 2016
tible to political uncertainty. I use term limits as an instrumental variable (IV) for election
Available online 8 April 2017
closeness. Because close elections are related to economic downturns, I find that the ef-
JEL Classification: fect of close elections on investment is understated by more than half by ordinary least
G31 squares (OLS). Post-election rebounds in investment depend on whether an incumbent is
G32 re-elected. Finally, I provide evidence that firms delay equity and debt issuances tied to
G38 investments before elections.

Keywords: © 2017 Published by Elsevier B.V.

Investment
Political uncertainty
Gubernatorial elections

1. Introduction this an “uncertainty tax” on the U.S. economy.2 However,

Whether political uncertainty in the United States has
an effect on economic activity is currently a topic of
debate. According to Moody’s Analytics Chief Economist,
Mark Zandi, “...the reason why our economy can’t get into
a higher gear is because of the uncertainty created by
Washington, that this brinkmanship which happens every
3, to 6, to 12 months is corrosive on our collective psy-
che and it’s weighing on our willingness and ability to take
risk.”1 Vanguard Group Chief Economist Joseph Davis calls
R ment decisions in the U.S.
I would like to thank an anonymous referee, René Stulz (the editor),
and my dissertation committee: Leonard Kostovetsky, G. William Schw-
ert, and Toni Whited. I also thank Matthew Gustafson, Steven Jens, Ron
Kaniel, and seminar participants from Southern Methodist University, Pur-
due University, Washington University in St. Louis, Tulane University, and
the University of Rochester for helpful comments and suggestions. This
paper was previously circulated under the title “Investment Around U.S.
Gubernatorial Elections.”
E-mail address: cjens@tulane.edu
1
Political uncertainty will continue to stunt economic growth, Forbes,
Janet Novack, October 16, 2013.
others have criticized the idea that this type of uncertainty
can slow economies,3 and there is a lack of empirical evi-
dence directly linking political uncertainty within the U.S.
to changes in firm behavior (Bloom, 2009). Existing em-
pirical evidence focuses on international samples, includ-
ing countries with far greater levels of political uncertainty
than is experienced in the U.S. (Julio and Yook, 2012) or
broad metrics that capture the effects of a variety of types
of uncertainty (Baker, Bloom and Davis, 2016; Gulen and
Ion, 2016). I fill this void in the literature by examining
how political uncertainty affects firm financing and invest-
Challenges to research in this area include separating
the effects of political cycles from the business cycle and
2
Federal government begins first shutdown in 17 years, Janet Novack,
Forbes, September 30, 2013.
3
World Economic Outlook (WEO): Coping with High Debt and Sluggish
Growth, World Economic and Financial Surveys, International Monetary
Fund, October 2012.

http://dx.doi.org/10.1016/j.jfineco.2016.01.034
0304-405X/© 2017 Published by Elsevier B.V.
564 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
measuring the effects of political uncertainty rather than
economic uncertainty or weaker economies, as spikes in
political uncertainty are correlated with increases in gen-
eral economic uncertainty (Baker and Bloom, 2013). To
control for these confounding effects, I use gubernatorial
elections, which are staggered across the business cycle,
as a source of political uncertainty and gubernatorial term
limits as an instrumental variable (IV) to isolate the ef-
fects of political uncertainty. Finally, I use a difference-in-
difference framework to establish causality and conclude
that both firm investment and financing activities related
to investment are causally affected by political uncertainty
in the U.S.
I find a 4.9% decline in the investment of firms head-
quartered in states with a gubernatorial election in the
following quarter, relative to the investment of firms in
states without an upcoming gubernatorial election. This
decline in investment is greater for firms more susceptible
to changes in state policy: small firms, which tend to be
more geographically concentrated, firms with more poten-
tial investments, politically sensitive firms, and firms with
high disinvestment costs.4 Additionally, volatility is higher
for firms in states about to elect a governor relative to the
volatility of firms in other states, directly linking the de-
cline in firm investment with an increase in firm-level un-
certainty.
I also find that the investment of firms headquartered
in states that elected a governor in the previous quarter
is higher than the investment of firms headquartered in
states that did not just elect a governor. However, the mag-
nitude of the post-election increase in investment depends
on whether an incumbent or a new governor is elected.
When an incumbent governor is elected, the post-election
increase in investment is of roughly the same magnitude
as the pre-election decline; investment seems to have been
postponed from Q3 of the election year to Q1 of the fol-
lowing year. As firms within the state have already ob-
served the governor, his policies, and his ability to work to-
wards achieving his policies, there is significant resolution
of uncertainty as soon as he is elected. In contrast, when
a new governor is elected, there is a small increase in Q1
investment, but the overall investment for the year after
the election is lower. This suggests that, even after the
election, uncertainty remains about the new governor’s ad-
ministration and agenda. An analysis of firm-level volatil-
ity supports this interpretation; volatility is higher for sev-
eral months after a new governor is elected, relative to the
volatility seen after an incumbent is re-elected.5
Closer elections should result in a greater decline in
pre-election investment. However, there is also the possi-
4 Abel (1983), Roberts and Weitzman (1981), and Bar-Ilan and Strange
Results presented in the online appendix.
5
Boutchkova, Doshi, Durnev and Molchanov (2011) link labor-intensive
industries and industries dependent on exports and contract enforce-
ment with higher volatility in times of higher political risk. Biakowski,
Gottschalk and Wisniewski (2008) find higher stock market volatility
around national elections, and Goodell and Vahamaa (2013) determine
that the VIX is higher when the outcome of the presidential election is
less certain. Kelly, Pástor and Veronesi (2016) build on the models in
Pástor and Veronesi (2012); 2013) to hypothesize how changes to firm
policy can affect options prices and find that, around national elections
and global summits, options tend to be more expensive.
bility for reverse causality—poor economic conditions in a
state, including low firm investment, can result in a more
hotly contested election as the constituency reacts to the
poor local economy (Atkeson and Partin, 1995; Van Dunk,
1997). Using term limits as an IV allows me to address
this source of endogeneity in measuring close elections,
resulting in a measure that isolates the effect of political
uncertainty, rather than just the effect of elections or
economic uncertainty, on firm investment. When using
term limits as an instrument, the decline in investment
caused by the higher political uncertainty associated with
close elections is greater than 15%, more than twice the
decline predicted with ordinary least squares.
Finally, I examine firms’ decisions to issue debt and eq-
uity around elections. I find that seasoned equity offerings
(SEOs) are less likely to occur in the year of an election,
and there is approximately a 10% increase in SEO activity
moving from the year of to the year after an election. Ad-
ditionally, while an SEO is generally positively related to
a firm beginning an investment project, firms with SEOs
during election years are less likely to begin an investment
project in that year than firms with SEOs in non-election
years. I also find that debt issuances are delayed before
elections, but only in the subsample of firms with the low-
est percentage of long-term debt expiring in the year of
the election, suggesting that issuances tied to investment,
but not issuances to replace existing debt, are delayed un-
der greater political uncertainty.
I make several contributions to the theoretical6 and
empirical7 literature on investment under general un-
certainty, as well as the literature examining political
uncertainty.8 First, I provide some of the first empirical
evidence that firms in the U.S. are causally affected by
political uncertainty. Several papers examine changes
in U.S. firm behavior associated with general economic
uncertainty: Stein and Stone (2013), Baker, Bloom and
Davis (2016), and Gulen and Ion (2016). Julio and Yook
(2012) use a binary election variable to measure the
effect of political uncertainty created by elections in an
international sample. My study differs in that I use an
all-domestic sample to confirm that political uncertainty
does affect U.S. firms and a difference-in-difference (DD)
framework to conduct my tests. A DD estimation has
the following advantage over an estimation using only a
binary election variable: If there is a gubernatorial election
in California, but not in Louisiana, the binary election
variable will capture any underlying differences between
the investment of firms headquartered in California and
Louisiana in addition to the effects of political uncertainty.
6
Predictions from early theory literature on investment under un-
certainty were mixed. Oi (1961), Hartman (1972), Hartman (1976),
(1996) predicted that higher levels of uncertainty would increase invest-
ment, while Bernanke (1983), Pindyck (1991), Bertola (1998), Dixit (1989),
and Leahy (1993) predicted a decline in investment in times of higher un-
certainty.
7
See Brainard, Shoven and Weiss (1980), Leahy and Whited (1996),
Pindyck and Solimano (1993), Caballero and Pindyck (1996), Hurn and
Wright (1994), and Bloom (2009).
8
See Alesina and Perotti (1996), Bloom, Bond and Van Reenen (2007),
Chen and Funke (2003), Gulen and Ion (2016), Julio and Yook (2012), and
Kelly, Pástor and Veronesi (2016).
 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
A DD estimation finds the difference between investment
levels of firms headquartered in California and Louisiana
before and during the pre-election period and nets out any
pre-existing differences, resulting in cleaner identification
of the effects of political uncertainty on firm investment.
This is the first study controlling for the endogeneity
inherent in measuring election closeness. While elections
are arguably an exogenous source of political uncertainty,
reverse causality can complicate quantifying the effects of
higher political uncertainty caused by closer elections on
investment, as more poorly performing economies are as-
sociated with stronger challengers (Van Dunk, 1997). Us-
ing term limits as an IV allows me to examine the effects
of elections and close elections on firm investment, which
is important because, if I do not look at some measure of
gradation of political uncertainty above the baseline level
of political uncertainty created by elections, I am unable
to determine whether my effects are caused by higher po-
litical uncertainty associated with elections or the election
cycle.
Finally, I provide evidence that gives a more complete
pictures of how firms’ behavior is affected by political
uncertainty: investment and disinvestment decline before
and rebound after elections; a spike in volatility corre-
sponds with the pre-election decline in investment; firms
postpone debt and equity issuances before elections; and
issuances that do occur in election years are less likely
to be associated with the start of a high-intensity invest-
ment period. Taken together, my results are consistent with
higher levels of political uncertainty in the U.S. affecting
firms’ investment and financing activities.
The paper proceeds as follows: motivation and hy-
potheses are in Section 2; Section 3 defines and dis-
cusses data and variables; the model and identification
are presented in Section 4; results and robustness are in
Section 5; and Section 6 concludes.
2. Motivation and hypotheses
If elections can create uncertainty about potential pol-
icy changes within states, firms will delay pre-election in-
vestment. Pástor and Veronesi (2012) define political un-
certainty as, “...uncertainty about the government’s future
actions.” Pástor and Veronesi (2012); 2013) and Kelly, Pás-
tor and Veronesi (2016) show how political uncertainty can
cause a rise in risk premia. Bernanke (1983) models irre-
versible investment, which will be delayed if uncertainty
affects project cash flows. Firms will delay pre-election in-
vestment if political uncertainty changes risk premia or ex-
pectations about project payoffs, or both.
The model of investment under uncertainty presented
in Bernanke (1983) explains the delay in firm investment
during greater political uncertainty. Right before an elec-
tion, a firm has a choice between investing in project A
or project B. The winner of the election can influence
state policies (investment incentives, minimum wage laws,
safety and environmental regulations, etc.) which affect the
payoffs of the projects. Both projects are costly to reverse
(there is some cost to switching between projects after the
election). The firm also has the option to defer investment
until after the election. If the outcome of the election is
565
certain, the firm will make an investment decision imme-
diately. However, if the election creates uncertainty, the
option value of deferral increases and the firm may post-
pone a marginally profitable project to the next period. The
more uncertain the election, the higher the value of defer-
ral, and the more likely a firm is to postpone investment
(Bernanke, 1983).
Pástor and Veronesi (2012); 2013) and Kelly, Pástor
and Veronesi (2016) demonstrate how political uncertainty
can affect risk premia. Pástor and Veronesi (2012) predict
that a rise in political uncertainty should decrease invest-
ment for some firms. Kelly, Pástor and Veronesi (2016) ex-
plicitly model the relation between political uncertainty
caused by elections and risk premia. Whether through the
irreversibility channel Bernanke (1983) proposes or risk
premia channel in Pástor and Veronesi (2012),Pástor and
Veronesi (2013) or Kelly, Pástor and Veronesi (2016), in-
vestment under higher political uncertainty should be ex-
pected to decline.
I use gubernatorial elections as a source of political un-
certainty. If the political uncertainty associated with guber-
natorial elections can affect firm behavior, two things must
be true: changes to state-level policies must affect firm in-
vestment behavior and governors must have sufficient con-
trol over these state-level policies such that an election,
and potential change in governor, induces uncertainty.
Gubernatorial elections will only cause a change in risk
premia, which should affect firm investment, if the polit-
ical risk associated with gubernatorial elections cannot be
diversified away. In the United States, there are four guber-
natorial election cycles; each year, at least two states are
holding a gubernatorial election. As there are only four cy-
cles, this limits firms’ abilities to diversify away risk from
gubernatorial elections. Regardless, even if this source of
political risk can be diversified away, changing state-level
policies can still affect firm investment decisions as pre-
dicted by the model in Bernanke (1983).
There are many examples of changes in state-level pol-
icy influencing firm investment decisions. In 2011, Alabama
enacted an immigration law (HB 56) that punished busi-
nesses who hired illegal immigrants. The law caused im-
mediate widespread labor shortages and uncertainty in the
agriculture, hotel and hospitality, construction, and fishing
industries.9 In July 2013, Walmart threatened to abandon
three stores mid-construction and cancel the groundbreak-
ing for three additional stores if the District of Columbia’s
City Council forced the firm to pay employees a “living
wage.”10 These examples demonstrate that actual changes
in state policies can affect firm investment.
If governors have sufficient control over state-level
policies, gubernatorial elections are a source of political
uncertainty. A large body of work examines whether
governors, state legislatures, or state agencies are more
influential in determining state-level policies.11 While
9
How America’s harshest immigration law failed, MSNBC, Benjy Sarlin,
December 16, 2013.
10
Walmart wins again as Washington D.C. mayor vetoes $12.50 mini-
mum wage, Forbes, Janet Novack, September 12, 2013.
11
See, for example: Abney and Lauth (1983), Abney and Lauth
(1998), Baranowski and Gross (2006), Brudney and Hebert (1987),
566 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
conclusions depend on the measures and techniques used,
the consensus is that governors do matter to state policies.
Although state-level variation in political uncertainty may
come from any of these entities, I use gubernatorial elec-
tions as they are the most observable source of state-level
political uncertainty. Gubernatorial elections are also used
to study the effects of political uncertainty on: initial pub-
lic offering (IPO) activity (Colak, Durnev and Qian, 2017),
the value of political connections (Do, Lee and Nguyen,
2015), and municipal bond markets (Gao and Qi, 2013).
The difference-in-difference framework, discussed further
in the model and identification section, will control for any
unobservable differences in other sources of state-level
political uncertainty.
I hypothesize that firms that delay investment will also
postpone costly financing activities. Pástor and Veronesi
(2012), Pástor and Veronesi (2013) and Kelly, Pástor and
Veronesi (2016) show political uncertainty affects risk pre-
mia, which can affect firms’ real financing activities. Addi-
tionally, all issuances are costly, and any costly-to-reverse
decision may be postponed during uncertainty (Bernanke,
1983).
This paper focuses specifically on issuances related to
investment. In any issuance decision, firms strategically
weigh costs and benefits, which will depend on the goals
of the issuance. For example, a debt issuance can have
many uses: to replace expiring debt, fund a project, ad-
just debt levels, or pay a dividend. Uncertainty about a pol-
icy change that would affect project cash flows and there-
fore investment decisions may not influence the decision
to relever. The costs of forgoing a dividend payment may
be so high that dividends are paid even during high po-
litical uncertainty. As the effects of uncertainty may vary
with issuance goals, I focus solely on issuances related to
periods of high-intensity investment.
There are several alternative explanations of the de-
cline in investment before elections. First, the political
business cycle hypothesis predicts that politicians manip-
ulate policies before elections to influence firm invest-
ment (Nordhaus, 1975). Evidence on the political busi-
ness cycle hypothesis has been mixed. Drazen (2001) finds
no evidence of a significant increase in economic activ-
ity before an election in the U.S. or any Organisation for
Economic Co-operation and Development (OECD) country.
However, Dinc (2005) and Cole (2009) find a significant in-
crease in the lending by government-owned banks in In-
dia prior to elections. Bertrand, Kramarz, Schoar and Thes-
mar (2006) find evidence of an increase in investment in
firms with a politically connected CEO before municipal
elections in France. Alternatively, firms can alter their in-
vestment behavior around elections to preserve or create
valuable political connections.12
Previous studies have tested against these alternative
hypotheses by removing politically connected firms from
Hebert, Brudney and Wright (1983), Kelleher and Yackee (2006), Sigelman
and Dometrius (1988), and Wright (1967).
12
There is a large literature demonstrating the value of firm political
connections to firms, including: Faccio (2006), Faccio, Masulis and Mc-
Connell (2006), Kostovetsky (2015), Bertrand, Schoar and Thesmar (2007),
and Do, Lee and Nguyen (2015).
the sample. If the decline in investment is present after
politically connected firms are removed, the decline must
be driven by something other than firm or politician ma-
nipulation (Julio and Yook, 2012; Faccio, 2006; Faccio, Ma-
sulis and McConnell, 2006). However, as Julio and Yook
(2012) note, this technique hinges on the researcher’s abil-
ity to correctly identify all firms with the incentives to ma-
nipulate investment around elections. Instead, to address
these hypotheses, I focus on examining other aspects of
firm decisions before elections. Since disinvestment is also
a costly-to-reverse decision, disinvestment should also de-
cline before elections (Bernanke, 1983). If politicians are
manipulating firm investment lower or firms are feigning
poor performance to manipulate election results, presum-
ably, investment will decline. If the goal is the illusion of
poor firm performance, disinvestment should increase or
at least should not decrease before the election. A decline
in disinvestment before elections, followed by an increase
after elections, is consistent only with the uncertainty hy-
pothesis.
3. Data and variables
3.1. Political and economic data and variables
I obtain election results and party identification of gov-
ernors from Congressional Quarterly (CQ) Press and hand-
collect term limit data. Election is a binary variable equal to
one if a gubernatorial election occurred in the firm’s state
of headquarters; pres. election is a binary variable equal to
one if the U.S. elected a president in that year. The sam-
ple includes all gubernatorial elections from 1984 to 2008,
spanning eight presidential elections. The only special elec-
tion in the sample took place in California in 2003; this ob-
servation is treated as all other election observations, and
its exclusion has no effect on the results.
Table 1 provides summary statistics for 1,250 state and
328 election-year observations. Close is a binary variable
equal to one if the vote differential, the difference in per-
centage vote received by the first and second place candi-
dates, is in the lowest tercile. Of the 328 elections in the
sample, 108 are defined as close. The average close elec-
tion has a vote differential of 3.7%, while the average non-
close election has an average vote differential of 22.9%. The
cutoff vote differential between close and non-close elec-
tions is 7.1%. Further discussion of the appropriateness of
this measure of election closeness, including an estimation
of election closeness from poll data, is included in the Ro-
bustness section.
Termlim, the IV for election closeness, is a binary vari-
able equal to one if the incumbent governor is facing a
binding term limit. Close elections are more than twice as
likely as non-close elections to be term limited elections
(36.1% vs. 15.9%). State-level variables are included in each
estimation to control for the economic conditions within
a state: the quarterly state unemployment rate (unemp) is
from the Bureau of Labor Statistics (bls.gov) and annual
change in state gross domestic product (GDP) is from the
Bureau of Economic Analysis (bea.gov). A binary variable
equal to one if the quarter is identified by the National Bu-
reau of Economic Research (NBER) as being in a recession
 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579 567

Summary statistics for firm-level variables for samples of 216,782 firm-quarter and 115,524 firm-year observations from 1984 to 2008. Panel A presents summary statistics for all quarterly variables in investment
Table 1

# of obs.

–
115,524
115,524
115,524

115,524

103,458
96,058
114,897
114,721
107,771
47,314

115,524
198,319
Summary statistics for state-level variables for the sample of 1,250 state-

114,611
year observations from 1984 to 2008. Unemp included in later regressions
is quarterly, but the unemployment variable presented here is annual (av-
erage of quarterly unemployment) for comparison with other annual vari-
ables. GDP is from the Bureau of Economic Analysis (bea.gov) and un-
emp is from the Bureau of Labor Statistics (bls.gov). Election data are from

sd

–
0.432
0.281
0.445

0.025
0.014

1.067

–
0.195
0.266
17.977
0.253
0.438

2.294
235.181
CQ Press, and term-limit data are hand-collected. See Appendix for vari-

Panel B: Annual observations – financing tests

able definitions.

Variable min median mean max sd # of obs.

Whole sample

341.0 0 0

6,338.0 0 0
max

1
1
1
–

–
0.178
0.146

4.306

–
1
1
913.293

21.430

10.912
unemp 0.0225 0.052 0.054 0.146 0.017 1,250
 GDP −0.310 0.055 0.057 0.178 0.032 1,250
dem 0 0 0.497 1 0.500 1,250
rep 0 0 0.490 1 0.500 1,250
other (3rd party) 0 0 0.013 1 0.112 1,250
election 0 0 0.262 1 0.440 1,250

mean

0.086

–
0.248

0.272

0.057
0.056

0.066

–
0.040
0.077
3.487
0.197
0.104
63.240
4.750
yearafter 0 0 0.267 1 0.196 1,250
govswitch 0 0 0.147 1 0.354 1,250
Election observations only (election = 1)
unemp 0.024 0.052 0.053 0.146 0.017 328
 GDP

median

0
0
0
–

0
0
0.056
0.054

0.035
1.311
0.106
0.022
6.376
4.783
–
−0.310 0.053 0.055 0.158 0.039 328

tests, and Panel B presents summary statistics for all annual variables used for financing tests. See Appendix for variable definitions and sources.
termlim 0 0 0.226 1 0.419 328
close 0 0 0.329 1 0.471 328
votediff 5E−5 0.128 0.166 0.648 0.139 328
Close election observations only (close = 1)

min

0
0
0
–

0
0
−0.310
0.023

−2.093
0.0268
0
0
−1.683
−2.779
–
unemp 0.024 0.054 0.057 0.146 0.019 108
 GDP −0.310 0.049 0.046 0.129 0.045 108
termlim 0 0 0.361 1 0.483 108
votediff 5E−5 0.039 0.037 0.071 0.020 108
Non-close election observations only (close = 0)
# of obs.

–
–
216,782
216,782
216,782
216,782

216,782
216,782
216,782

216,782
216,782
216,782
216,782
216,782
216,782
175,428
unemp 0.025 0.050 0.052 0.117 0.016 220
 GDP −0.148 0.057 0.059 0.158 0.035 220
termlim 0 0 0.159 1 0.367 220
votediff 0.074 0.191 0.229 0.648 0.128 220
Year-after observations only (yearafter = 1)
sd

0.434
0.276

0.216
0.478

0.333
0.025
0.014

–
–
3.431
8.139
0.355
0.743
0.124
2.243
27.522
govswitch 0 1 0.508 1 0.501 321
Panel A: Quarterly observations – investment tests

(recession) is also included as a control variable in each es-

max

1
1
1
1

–
–
0.158
0.149

101.551
478.340
42.166
99.875
0.298
12.285
11,390.480
timation.

3.2. Firm data and variables

3.2.1. Investment data and variables

mean

0.083

0.049
0.251

0.278

0.127
0.057
0.055

–
–
2.014
2.766
0.201
0.088
−0.013
4.779
0.564
Panel A of Table 2 presents summary statistics for firm-
quarter-level variables, including economic and political
variables that have been matched with quarterly firm ob-
servations. All financial control variables used in tests of
median

0
0
0
0

0
−0.056
0.053

–
1.064
1.508
0.127
0.017
0.017
4.734
0
–

firm investment and disinvestment are from the Compus-

tat Quarterly files. The data run from Q1 of 1984, which is
the earliest quarter investment data are available, to 2008,
so that the last elections covered by the year-after-election
1.4E−4
min

0
0
0
0

0
−0.148
0.021

0.0359
0
−0.050

–
–
−3.028
−8.805
−31.294

sample occurred in November 2007, purposely omitting

observations from the financial crisis. The DD model can-
not identify the effects of political uncertainty caused by
gubernatorial elections, annual fixed effects, and the effects
short-term debt/assets

of the financial crisis. Since the paper is aimed at isolating

Macroeconomic controls

long-term debt/assets

sale of PPE/assets (%)

the effects of political uncertainty, years within the finan-

Financial variables

cash flow/assets
capex/assets (%)
market-to-book
Political variables

cial crisis are omitted, although the results are robust to

ln(market cap)
pres. election

the inclusion of 2009. The Results section further discusses

debtissue
recession

how an economic downturn coinciding with elections can

termlim
election

 GDP
unemp
Variable

close

affect the DD estimation.

SEO
Table 2

I drop observations with missing information, total as-

sets equal to or less than zero, or capital expenditures less
568 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579

than zero. Investment is measured by capital expenditures Table 3

The number of debt issuances and SEOs for each state. Debt issuance and
scaled by total assets. There are only a handful of observa-
SEO samples run from 1984 to 2013. See Appendix for variable definitions
tions with capital expenditures greater than 1.5 times as- and sources.
sets; I exclude these as probable data errors. Disinvestment
State Debt SEOs State Debt SEOs
is sale of property, plant, and equipment (PPE) scaled by
issuances issuances
total assets.
Cyclicality in firms’ annual investment poses a potential Alabama 81 43 Montana 6 5
Alaska 0 3 Nebraska 25 10
problem in a DD estimation, so I drop firms without fis-
Arizona 76 80 Nevada 28 52
cal year-end in December. Shin and Kim (2002) show that Arkansas 21 14 New Hampshire 8 17
most firms’ investment follows a predictable cycle over the California 376 777 New Jersey 182 179
firms’ financial year, dropping from Q1 to Q2, remaining Colorado 58 150 New Mexico 5 17
Connecticut 230 144 New York 435 360
low for Q2 and Q3, and rising in Q4. A DD model compares
Delaware 66 19 North Carolina 102 87
levels of firm investment in, for example, the third quar- Florida 137 162 North Dakota 9 4
ter of the year. If firms’ investment cycles are staggered, Georgia 141 127 Ohio 257 133
the third quarter of the year may coincide with Q3 in one Hawaii 10 11 Oklahoma 29 58
firm’s fiscal year but Q2 for another firm; yet, these quar- Idaho 4 12 Oregon 36 50
Illinois 424 197 Pennsylvania 141 186
ters are not directly comparable. Rather than control for
Indiana 103 66 Rhode Island 46 6
fiscal year-end in my model with another indicator variable Iowa 39 23 South Carolina 29 24
and appropriate interactions, I choose to omit firms with- Kansas 9 20 South Dakota 6 7
out fiscal year-end in December. This results in the third Kentucky 22 30 Tennessee 47 111
Louisiana 16 36 Texas 468 559
quarter of the year being fiscal Q3 for every firm, which
Maine 10 9 Utah 18 29
are directly comparable in the DD model. The final sample Maryland 82 140 Vermont 0 8
includes 216,782 firm-quarter observations. Massachusetts 110 240 Virginia 159 139
Financial controls included in each estimation include: Michigan 216 102 Washington 72 95
market-to-book ratio, cash flows scaled by total assets, Minnesota 69 77 West Virginia 2 6
Mississippi 18 18 Wisconsin 91 48
firm size (log of market capitalization), short-term debt,
Missouri 67 58 Wyoming 0 0
and long-term debt. The inclusion of market-to-book and Total 4,586 4,748
a measure of cash flows is standard in such a regression
(Julio and Yook, 2012; Gulen and Ion, 2016). Since the
goal of the estimation is to measure the effects of politi-
imum number of states available for cross-sectional com-
cal uncertainty caused by election cycles, it is particularly
parison.
important to control for variables related to investment
Firms without year-end in December are omitted be-
cycles. Market capitalization is included as a measure of
cause fiscal year cyclicality in firm investment may pose
firm size. I expect that smaller firms, which are probably
estimation issues in a DD framework. Firms with miss-
younger firms, have greater intensity of investment. Addi-
ing total assets and financial (SIC codes between 60 0 0 and
tionally, DeAngelo, DeAngelo and Whited (2011) demon-
6999) and utilities (SIC codes between 4900 and 4999)
strate the importance of debt, specifically, modeling both
firms are also excluded. Control variables are constructed
transitory and perpetual debt, to funding investment and
identically for the investment and financing samples, ex-
investment cycles. According to DeAngelo, DeAngelo and
cept that the investment sample comprises quarterly ob-
Whited (2011), short-term debt is not the same as tran-
servations and the financing sample comprises annual ob-
sitory debt, so, for robustness, I also consider measures of
servations. I create a binary high investment variable (high-
book and market leverage (effectively, in including short-
inv), equal to one if the annual capital expenditure for a
and long-term debt, I include the components of book
firm is greater than 1.5 times the firm’s average annual
leverage). Results are unchanged.
capital expenditure until that point and zero otherwise
(Dudley, 2012). A project is defined as more than one con-
3.2.2. Financing data and variables
secutive highinv year. The beginning of a project (begproj)
Debt issuance and SEO data are from SDC Platinum. Be-
is a binary variable equal to one for the first year of a
cause data are frequently missing before 1984, I begin the
project and zero otherwise.
sample in 1984. I match the issuance data with annual
Compustat financial data and create binary debt issue and
SEO variables equal to one for years in which a firm had 3.2.3. Other firm-level variables
a debt issuance or an SEO, respectively. I use annual data Daily returns used to compute volatility are from the
to maximize the number of states included in the sam- Center for Research in Security Prices (CRSP). Volatilities
ple. Quarterly data were used for the investment tests be- are measured as the square root of a stock’s mean squared
cause almost all firms report investment every quarter. In daily return over the course of a calendar month. To com-
contrast, SEOs and debt issuances are relatively rare, oc- pare volatility across states before elections, I compute
curring in only 4% and 7.7% of firm-years, respectively (see state averages of the logged volatilities—I use the logarithm
Table 3). Were I to use quarterly data, only 1% of quarterly because the volatilities are highly skewed.
observations would have an SEO. In a DD model, if no SEOs All variable definitions, including a more detailed de-
occur in Alabama in Q1, Alabama in Q1 would drop out of scription of the 10-K state count procedure, are given in
my sample. Using annual observations preserves the max- Appendix.
 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
4. Model and identification
4.1. Identifying the effects of political uncertainty on
investment
There are three major challenges to estimating effects
caused by political cycles: measuring the political uncer-
tainty rather than general economic uncertainty, estab-
lishing causality, and separating the political/election cycle
from the business cycle. My identification strategy allows
me to address each of these concerns.
First, I use gubernatorial elections as a relatively
straightforward and observable source of political uncer-
tainty. To measure only the effects of political uncertainty
on firm actions, it is necessary to use an event like an elec-
tion or a global summit (Kelly, Pástor and Veronesi, 2016)
instead of a broader uncertainty index, like the one cre-
ated in Baker, Bloom and Davis (2016) and used in Gulen
and Ion (2016). The Baker, Bloom and Davis (2016) index
is designed to measure economic uncertainty and is cor-
related with not only presidential elections, but also wars
(the First and Second Gulf Wars), terrorist attacks (9/11),
major stock market events (Black Monday), and the recent
financial crisis. Although some of the uncertainty associ-
ated with these events may be political uncertainty, e.g., is
Congress going to enact laws to try and prevent a second
financial crisis?, there are other sources of uncertainty, e.g.,
will changes to interest rates take place?, which are impos-
sible to disentangle using only this index.
Second, the exogenous nature of elections allows me
to estimate the following difference-in-difference model to
establish causality:
investment = β0 + β1 election + β2 Q3 + β3 pres. election
+ β4 election × Q3 + β5 pres. election
× election + β6 pres. election × Q3
+ β7 pres. election × election
× Q3 + δ controls + u.
The DD model uses firms in states without an upcoming
election as the control group for a treated sample of firms
in states about to elect a governor. The coefficient esti-
mated for Q3 captures any effect that the time of the year
may have on firm investment, which is important to con-
trol for given the annual cyclicality of investment. The co-
efficient on election captures any effects that the election
cycle may have on firm investment; any underlying differ-
ences between firms headquartered in election and non-
election states should also be captured by this coefficient.
The coefficient of interest is the interaction between elec-
tion and Q3, which measures only the added effect of po-
litical uncertainty in Q3, the quarter directly preceding the
election (Roberts and Whited, 2012).
To establish a causal link using a DD model, there are
a number of assumptions that must hold. First, the treat-
ment, here, election, must be exogenous. There can be no
self-selection into the election cycle of a state in which a
firm is headquartered. Although firms can make strategic
decisions concerning their state of headquarters, the mo-
tivation is likely to be, for example, avoiding state income
569
taxes.13 To be problematic for this estimation, firms would
need to be self-selecting into specific election cycles, which
is unlikely. Firms also cannot have influence over the years
in which an election is held. For most states, the sample
here occurs long after the gubernatorial election cycle was
established, as election cycles are typically related to the
year in which a state constitution was ratified.14 Finally,
there should be no significant underlying differences in
firm investment levels between firms in different election
cycles and there should be no lead or lag in the effect of
political uncertainty on investment (Roberts and Whited,
2012). As can be seen in Fig. 1, for both all firms (dark
colored bars) and firms in states with off-presidential year
gubernatorial elections (light colored bars), there is almost
no difference in investment before Q3. The effect of politi-
cal uncertainty on investment is concentrated to the quar-
ter directly preceding the election.
The final challenge to identification is separating the ef-
fects of the political cycle from the business cycle. Unlike
presidential elections, which could coincidentally line up
with the business cycle, gubernatorial elections are stag-
gered, with at least two elections occurring in each year. To
ensure my results are caused by political uncertainty asso-
ciated with elections, rather than the elections themselves,
I look at investment before both elections and close elec-
tions, which should create higher levels of political uncer-
tainty. Although the timing of gubernatorial elections is ar-
guably exogenous, there is the potential for reverse causal-
ity when measuring election closeness—economic uncer-
tainty, including lower firm investment, can, in turn, cause
closer elections, as incumbent governors may be blamed
by a dissatisfied electorate for deteriorating economic con-
ditions (Atkeson and Partin, 1995) and face stronger chal-
lengers during poorer economies (Van Dunk, 1997). To ad-
dress endogeneity in measuring close elections, I use term
limits as an instrumental variable.
Term limits create an increase in political uncertainty
by preventing the incumbent governor from seeking re-
(1) election.15 As incumbents overwhelmingly win re-election
(in my sample, 84.75% of incumbents win re-election),
the absence of an incumbent results in a closer election
(see Table 1). It is necessary to use term limits as an
IV rather than incumbent-free elections because governors
make strategic decisions. Incumbents may not seek re-
election if they believe their chances for re-election are
lower due to poorer economic conditions within the state
(Atkeson and Partin, 1995; Van Dunk, 1997).
For term limits (termlim) to be considered a valid IV,
the variable must satisfy both the relevance and exclusion
13
How Apple sidesteps billions in taxes, Charles Duhigg and David Ko-
cieniewski, The New York Times, April 28, 2012.
14
For example, Kentucky, Louisiana, Mississippi, New Jersey, and Vir-
ginia all hold elections in odd-numbered years. The Virginia general as-
sembly adopted a constitution in 1851; the first governor under that con-
stitution was elected in 1851. The current constitutions of Louisiana and
New Jersey were adopted in odd years, 1879 and 1947, respectively. Mis-
sissippi has held its gubernatorial elections in odd-numbered years since
the 1830s. Changes to election cycles are rare and require a change to
the state constitution. The last change to a gubernatorial election cycle in
the U.S. occurred in 1984, when Arkansas switched from a two-year to a
four-year cycle (Amendment 63 of the Arkansas state constitution).
15
Benefits to incumbency are well-documented (Cover, 1977).
570 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579

Fig. 1. The difference in average quarterly investment for election and non-election years, close election and non-close election years, and close election
and non-close election years for a sample of 216,782 firm-quarter observations from 1984 to 2008. Investment is capital expenditures as a percentage of
total assets times 100. The sample average investment is 2.014. In the top panel, the height of the bars is equal to election-year investment minus non-
election year investment. In the middle panel, the height of the bars equals close election-year minus non-close election-year investment. In the bottom
panel, the height of the bars equals investment in close election years minus the investment in non-election years. For all panels, the dark color bars are
these differences for all firms in the sample. For the light color bars, the sample was limited to firms with gubernatorial elections that do not occur at the
same time as presidential elections. Close elections are defined using the election day vote differential (difference in percentage votes received by the first
and second place candidates). Close elections have a vote differential in the lowest tercile of sample vote differential.

conditions (Roberts and Whited, 2012). To empirically test
the relevance condition, which requires termlim to be cor-
related with close, “...after netting out the effects of all
other exogenous variables...,” I regress the binary close-
ness variable (close) on termlim, a binary variable equal to
one for presidential election years, variables measuring the
economic conditions within a state, and state averages for
firm-level variables used as controls in the second-stage
regression16 (Roberts and Whited, 2012). The term limits
variable is significantly related to election closeness; the
F-statistic is 15.56 and the R2 of the regression is 31.8%,
alleviating concerns that the instrument may be weak.17
16
The variables included in the regression are: termlim, preselection, un-
emp, GDP, ltdebt, stdebt, cash flow, ln(marketcap), market-to-book. Results
for the first-stage regression are omitted for brevity but are available in
the online appendix.
17
In the Robustness section, I consider an alternate definition of elec-
tion closeness, based on the average, instead of tercile, election outcome.
When I repeat the first-stage regression of close on termlim and controls,
The exclusion condition requires that the only effect
term limits have on firm investment comes through elec-
tion closeness. There is no test for the exclusion condition
(Roberts and Whited, 2012); determining whether term
limits passes the exclusion condition requires understand-
ing the relation between election closeness and term lim-
its. Term limit laws are specified in state constitutions, so
it is unlikely that any actors, whether firms or governors,
would be able to change these laws to serve their inter-
ests.18 Setting aside the possibility of statute changes, to
breach the exclusion condition, termlim must be correlated
with investment in some way that termlim is not corre-
lated with election closeness.
One possible challenge to instrument validity is the al-
ternate explanations for changes in firm investment around
the F-statistic is 13.36 and the R2 is 44%. The instrument also satisfies the
relevance criteria for this alternate definition of election closeness.
18
There is one change in term limit laws during the sample. In 1992,
Amendment 73 to the Arkansas state constitution was passed, which lim-
ited the governor to a maximum of two elected terms in office.
 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
elections—either firms or politicians can try to manipulate
firm investment to influence election results. First, it is im-
portant to question whether the possibility of such manip-
ulation is even relevant in a sample of all-domestic firms.
All evidence of either firm or politician manipulation of
investment around elections has been found in countries
other than the U.S. (Dinc, 2005; Cole, 2009; Bertrand, Kra-
marz, Schoar and Thesmar, 20 06). Drazen (20 01) finds no
evidence of changes in economic activity before elections
in the U.S. or in any other OECD country. These alternative
explanations are further tested in the Robustness section
of this paper; I also do not find any evidence supporting
these hypotheses.
Second, it is important to remember the goal of this
manipulation—either to bring about a change in adminis-
tration or to keep the current administration, whichever is
desired by politicians or firms. Stated alternately, the goal
of this manipulation is to affect the outcome of the elec-
tion. Election closeness is defined from election results. Al-
though this paper, and previous studies, find no evidence
of manipulation in the U.S., even if such manipulation ex-
ists, it is difficult to tell a story that decouples manipula-
tion from election closeness. In the absence of a link be-
tween investment and term limits unrelated to election
closeness, it is reasonable to conclude that termlim satis-
fies both the relevance and exclusion conditions and is a
valid instrument for election closeness.
To estimate the effects of higher political uncertainty
caused by close elections on firm investment, I estimate
the following equation, using a measure of election close-
ness fitted from the first stage of the IV procedure:
investment = β0 + β1 close + β2 Q3 + β3 pres. election
+ β4 close × Q3 + β5 pres. election
× close + β6 pres. election × Q3
+ β7 pres. election × close
× Q3 + δ controls + u.
Because all close elections are elections, I cannot include
an interaction between close and election, so I limit the
sample to only election years to estimate the difference be-
tween the investment of firms in states with a close elec-
tion and the investment of firms in states with a non-close
election. The interpretation of the coefficient on close × Q3
is the added effect of the political uncertainty from close
elections, above the effect of political uncertainty created
by elections in general.
A potential confounding source of political uncertainty
created by gubernatorial elections is political uncertainty
created by the presidential election cycle. To control for
the possibility that the decline in investment in the sample
is driven by uncertainty created by presidential elections,
Eqs. (1) and (2) include a third treatment effect, presi-
dential election. In a difference-in-difference-in-difference
(DDD) model including election, pres. election, and Q3 as
treatments, the estimated effect of political uncertainty
from gubernatorial elections in the third quarter is net of
the effect of political uncertainty from presidential elec-
tions for the year and in the third quarter. Fig. 1 shows
that the difference in investment for firms headquartered
in election vs. non-election states is minimal until Q3 of
571
an election year for all firms, as well as in the sample for
which firms in the 12 states with presidential year guber-
natorial elections are omitted. This suggests that political
uncertainty beyond the uncertainty created by presidential
elections affects firm investment.
4.2. Identifying the effects of postponing investment on firm
financing activities
Firms should postpone obtaining costly financing for in-
vestments during times of greater uncertainty. Simply esti-
mating whether firms are less likely to issue equity or debt
in election years will not demonstrate whether the post-
ponement is directly linked to delayed investment. I esti-
mate a model aimed at isolating the effect of uncertainty
on issuances related to financing investment:
begproj = β0 + β1 issuance + β2 election
+ β3 issuance × election
+ β4 pres. controls + δ controls + u. (3)
If the coefficient on issuance is positive, issuances are pos-
itively related to firms beginning investment projects. The
coefficient on election is expected to be negative if firms
are less likely to begin investment projects when political
uncertainty is higher. If the coefficient on the interaction
between issuance and election is negative, conditional on
there being an election, an SEO is less likely to be asso-
ciated with the start of a high-intensity period of invest-
ment (begproj = 1). The estimation controls for: the pres-
idential election cycle, state economic effects (unemp and
GDP), and firm characteristics related to investment—
leverage (mktlev), market-to-book, cash flows, and size (ln-
marketcap) (Dudley, 2012).
5. Results
5.1. Main results
(2)
Table 4 presents the results for a DDD estimation with
election, presidential election, and quarter as treatments.
Each column reports the results from a regression with a
different quarter, given in the column header, used as the
treatment in the DDD estimation. The coefficient on the in-
teraction between election and Q3 and is negative and sig-
nificant; there is a decline in investment in the third quar-
ter, the quarter directly preceding a gubernatorial election.
This effect is limited to Q3; the coefficients on interac-
tions between election and Q1, Q2, and Q4 are not signifi-
cant. The dependent variable, investment, is capital expen-
ditures as a percentage of assets, so the interpretation of
the coefficient is a basis point change. With a sample av-
erage investment of 2.014, the decline in investment in Q3
is −0.099, or a 4.9% decline in the investment rate. When
the presidential election variables and interaction terms
are excluded, the estimated coefficient is slightly smaller,
−0.095, with a standard error of 0.040; the conclusions re-
main unchanged.19
Larger firms have higher levels of scaled investment,
as do firms with higher short- and long-term debt levels.
19
Results presented in online appendix.
572 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579

Table 4 in the state of headquarters. Firms that are more geograph-

Results using a sample of 216,782 firm-quarter observations from 1984 to
ically concentrated tend to be, on average, smaller firms.
2008 for a DDD estimation with election, pres. election, and quarter. The
quarter used in the interaction is given in the column header. The depen- Panel A of Table 5 presents differences in state average
dent variable is investment, capital expenditures as a percentage of total firm volatility for the six months pre-election and the elec-
assets times 100. The sample average investment is 2.014. See Appendix tion month (November). The volatility of firms headquar-
for variable definitions and sources. Standard errors are double clustered tered in states about to elect a governor is higher than
by year and state and given in parentheses below coefficient estimates.
the volatility of firms in other states from June to Octo-
Statistical significance at the 0.01∗∗∗ , 0.05∗∗ , and 0.1∗ level is designated
by asterisks. ber. The volatility is 3.8% higher in June. The peak differ-
ence in volatility occurs in August and September, 10.1%
Quarter Q1 Q2 Q3 Q4
and 8%, respectively. In October, the difference is just sta-
∗∗∗ ∗∗∗ ∗∗∗
Intercept 1.684 1.683 1.682 1.690∗∗∗ tistically significant at 2.9%. Elections occur in the first half
(0.184) (0.185) (0.185) (0.184)
of November, and there is no difference in average firm
election 0.006 −0.005 0.031 −0.005
(0.047) (0.046) (0.048) (0.045) volatility between states during that month. The greatest
election × quarter 0.005 0.045 −0.099∗∗ 0.047 differences in volatility occur in the months comprising
(0.046) (0.047) (0.044) (0.086) Q3, directly coinciding with the drop in firm investment.
pres. election 0.130 0.114 0.094 0.097 Closer elections should cause a higher level of political
(0.106) (0.104) (0.108) (0.108)
uncertainty and a greater drop in investment leading up to
pres. election × quarter −0.069∗ −0.022 0.033 0.053
(0.038) (0.033) (0.032) (0.046) the election. Table 6 presents only the coefficients on the
pres. election × election 0.128 0.134 0.109 0.190∗ interaction between election closeness and quarter from a
(0.093) (0.101) (0.104) (0.099) DDD estimation with close, pres. election, and quarter as
pres. election× 0.049 0.025 0.130 −0.203
treatments. In the top panel, the closeness measure equals
election × quarter (0.097) (0.098) (0.089) (0.143)
 GDP 5.730∗∗∗ 5.734∗∗∗ 5.733∗∗∗ 5.740∗∗∗
one if the election vote differential (the difference in vote
(0.986) (0.987) (0.986) (0.989) between the first and second place candidates) is in the
recession −0.003 −0.001 0.010 −0.001 lowest tercile of sample vote differentials. In the bottom
(0.103) (0.104) (0.109) (0.101) panel, the closeness measure is fitted from a first-stage es-
unemp −0.040∗∗ −0.040∗∗ −0.040∗∗ −0.040∗∗
timation of close on termlim (the IV) and controls. The sam-
(0.017) (0.017) (0.017) (0.017)
Q1 -0.167∗∗∗ -0.178∗∗∗ -0.184∗∗∗ -0.184∗∗∗ ple is limited to election-year observations, so the model
(0.020) (0.017) (0.017) (0.017) measures the investment of firms in states with close elec-
Q2 – −0.002 – – tions relative to the investment of firms in states with non-
(0.021)
close elections. The coefficient on the unfitted closeness
Q3 −0.006 – 0.007 −0.006
(0.015) (0.019) (0.015)
variable corresponds with a 7.3% decline in investment in
Q4 0.349∗∗∗ 0.355∗∗∗ 0.348∗∗∗ 0.327∗∗∗ Q2. However, when using the fitted closeness variable from
(0.024) (0.023) (0.024) (0.032) the first-stage estimation on termlim, this decline in Q2 in-
market-to-book 3.1E−4∗∗∗ 3.1E−4∗∗∗ 3.1E−4∗∗∗ 3.1E−4∗∗∗ vestment rises to 15.1%. The decline in investment for close
(1.2E−4) (1.2E−4) (1.2E−4) (1.2E−4)
elections starts earlier in the year and is stronger than the
cash flow −0.171∗∗∗ −0.172∗∗∗ −0.172∗∗∗ −0.172∗∗∗
(0.037) (0.037) (0.037) (0.037) decline estimated before all elections. Without the instru-
lt debt 0.109∗∗ 0.109∗∗ 0.109∗∗ 0.109∗∗ mental variable procedure, the effect of close elections is
(0.046) (0.046) (0.046) (0.046) understated by more than half, which is likely due to some
st debt 0.181∗∗∗ 0.181∗∗∗ 0.181∗∗∗ 0.181∗∗∗
of the decline in investment caused by higher political un-
(0.054) (0.054) (0.054) (0.054)
market cap 0.015∗∗∗ 0.015∗∗∗ 0.015∗∗∗ 0.015∗∗∗
certainty being misattributed to a weak economy.
(0.005) (0.005) (0.005) (0.005) The effect of political uncertainty on investment can
be confounded by economic weakness in two ways. First,
state/industry/year FE yes yes yes yes
reverse causality—lower firm investment causing closer
sample size 216,782 216,782 216,782 216,782 elections—can bias the results (Atkeson and Partin, 1995;
no. of clusters 1,204 1,204 1,204 1,204
Van Dunk, 1997). Second, the DD framework will estimate
R2 0.096 0.096 0.096 0.096
a lower effect of close elections on investment if close
elections are related to economic downturns. In a poor
Market-to-book ratio is positively related to investment. economy, firm investment will be depressed. If the DD
Although many studies in the literature report a positive model compares pre- and post-treatment investment,
relation between cash flow and investment,20 I find a neg- and firm investment is lower pre-treatment in Q2, the
ative relation. This is likely due to other studies leaving difference in investment between Q2 and the treated
microcap firms out of their samples. When the model is quarter, Q3, will be lower on an absolute basis than the
re-estimated on subsamples divided by size (total assets), decline in stronger economies. Therefore, if close elections
the coefficient on cash flows is positive for the highest and are related to economic weakness, the DD model will
negative for the lowest quintile. In the robustness section, I estimate a smaller decline in firm investment caused by
consider whether my results are driven by these microcap close elections. The fitted closeness variable includes only
firms and find that firms with strong geographic concen- information from term limited elections, which are not
tration are most strongly affected by political uncertainty correlated with economic conditions. Therefore, in the ab-
sence of the endogeneity brought on by lower investment
causing closer elections, a larger effect of close elections
20
See, for example, Gulen and Ion (2016). on investment is measured.
 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579 573

Table 5
Differences in average monthly volatility. Volatility is the log of squared daily returns. Daily return data are from CRSP. Monthly averages for firms head-
quartered in different states are compared. Panel A presents the difference between election-year and non-election year volatility, and Panel B presents the
difference between close election-year and non-close election-year volatility. The difference between volatility after an incumbent governor has won and
when there is a switch in governor is in Panel C. Panel D limits the year-after election sample to years after close elections only, and looks at the difference
in volatilities following the election of an incumbent or a new governor. See Appendix for variable definitions and sources. Statistical significance at the
0.01∗∗∗ , 0.05∗∗ , and 0.1∗ level is designated by asterisks.

Panel A: Election-year minus non-election year volatility

May June July Aug Sept Oct Nov

difference −0.014 0.038∗∗ 0.062∗∗∗ 0.101∗∗∗ 0.080∗∗∗ 0.029∗ −0.018
(0.018) (0.019) (0.020) (0.020) (0.019) (0.017) (0.019)
sample size 25 25 25 25 25 25 25

Panel B: Close election-year minus non-close election-year volatility

May June July Aug Sept Oct Nov

difference 0.044 0.036 0.051 0.039 0.019 0.052 0.038
(0.044) (0.042) (0.047) (0.040) (0.043) (0.049) (0.035)
sample size 22 22 22 22 22 22 22

Panel C: Governor switch minus incumbent victory volatility

Jan Feb March April May June July

difference 0.031 0.035 0.024 0.032 0.016 0.023 0.029
(0.035) (0.036) (0.027) (0.038) (0.029) (0.048) (0.050)
sample size 18 18 18 18 18 18 18

Panel D: Governor switch minus incumbent victory volatility for years after close elections only

Jan Feb March April May June July

difference 0.032 0.063∗∗ 0.022 0.036 −0.007 0.008 −0.018
(0.034) (0.028) (0.041) (0.033) (0.032) (0.033) (0.042)
sample size 13 13 13 13 13 13 13

Table 6 Table 7
Results using 54,711 gubernatorial election-year quarterly observations Only the yearafter and yearafter × Q1 terms from a DDD estimation of
from 1984 to 2008 for a DDD estimation with close, pres. election, and yearafter, yearafter pres., and Q1. The whole sample estimation, in the first
quarter. The quarter used in the interaction is given in the column header. column, includes 216,782 firm-quarter observations from 1984 to 2008.
The dependent variable is investment, capital expenditures as a percent- The governor switch = 1 column includes observations for the year af-
age of total assets times 100. Firm and macroeconomic controls are in- ter a new governor is elected. The governor switch = 0 column includes
cluded: market-to-book, cash flow, lt debt, st debt, market cap, GDP, re- observations for elections won by an incumbent governor; only year-after
cession, and unemp. The variable fitted close is the predicted values from observations for close elections won by incumbents are included in the fi-
a first-stage regression of close on termlim and controls (first-stage results nal column. The dependent variable is investment, capital expenditures as
available in the online appendix). See Appendix for variable definitions a percentage of total assets times 100. Firm and macroeconomic controls
and sources. Standard errors are double clustered by year and state and are included: market-to-book, cash flow, lt debt, st debt, market cap, GDP,
given in parentheses below coefficient estimates. Year, state, and industry recession, and unemp. See Appendix for variable definitions and sources.
fixed effects are included. Statistical significance at the 0.01∗∗∗ , 0.05∗∗ , and Standard errors are double clustered by year and state and given in paren-
0.1∗ level is designated by asterisks. theses below coefficient estimates. Statistical significance at the 0.01∗∗∗ ,
0.05∗∗ , and 0.1∗ level is designated by asterisks.
Panel A: Results without instrumental variable
Variable Whole Governor Governor switch = 0
Q1 Q2 Q3 Q4
close × quarter 0.088 −0.147∗ −0.100 0.158 sample switch = 1 All obs. Close elec.
(0.078) (0.087) (0.107) (0.201) ∗ ∗∗∗
yearafter −0.093 −0.147 0.056 −0.069
firm/economy controls yes yes yes yes (0.048) (0.049) (0.057) (0.261)
state/industry/year FE yes yes yes yes yearafter × Q1 0.073∗∗ 0.079∗ 0.064 0.579∗
sample size 54,711 54,711 54,711 54,711 (0.034) (0.042) (0.043) (0.304)
no. of clusters 320 320 320 320 firm/macroeconomic yes yes yes yes
R2 0.078 0.078 0.078 0.078 controls
state/industry/year FE yes yes yes yes
Panel B: Results using fitted closeness (2nd stage of IV estimation)
sample size 216,782 189,909 183,667 14,030
Q1 Q2 Q3 Q4 no. of clusters 1,204 1,055 1,025 230
fitted close × quarter 0.082 −0.304∗∗ 0.221 0.002 R2 0.096 0.118 0.094 0.121
(0.189) (0.142) (0.161) (0.151)
firm/macroeconomic controls yes yes yes yes
state/industry/year FE yes yes yes yes
sample size 43,402 43,402 43,402 43,402 and quarter as treatments. As expected, the coefficient
no. of clusters 222 222 222 222 on the interaction between yearafter and Q1 is positive,
R2 0.175 0.175 0.175 0.175
corresponding to a 3.6% increase in investment in the
quarter following gubernatorial elections. However, the
Table 7 presents only the coefficients on yearafter and coefficient on yearafter is negative, suggesting that, while
yearafter × Q1 from a DDD estimation with indicators for there is higher investment in the quarter following a gu-
the year after the election, year after presidential election, bernatorial election, relative to other Q1 investment levels,
574 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579

the investment in the whole year following a gubernatorial Table 8

election is lower than the investment levels in other years.
This result may seem puzzling, as elections are ex-
pected to resolve political uncertainty, and a resolution of
uncertainty should lead to a bounce-back in investment.
However, if a new governor is elected, a governor who has
not previously held office in the state, uncertainty can still
remain. I partition the sample into elections in which a
new governor was elected (govswitch = 1) and elections
in which the incumbent was re-elected (govswitch = 0).
The second column of Table 7 presents the results from a
DDD estimation including year-after observations only for
elections won by new governors. While there is a weakly
significant increase in investment in the quarter following
such elections, the Q1 effect is dominated by the over-
Results for the estimation of a logit model with begproj, equal to one for
the first year in which investment measured by scaled capital expendi-
tures is greater than 1.5 times the firm’s historic average and zero other-
wise, on firm, presidential, and macroeconomic controls. The whole sam-
ples include 41,808 and 41,864 observations from 1984 to 2008 for the
SEO (column 1) and debt (column 2) estimations, respectively. Presiden-
tial controls included are binary variables for presidential election years
and interactions between: pres. election and election, either SEO (column
1) or debtissue (columns 2–4) and pres. election, and either SEO (column 1)
or debtissue (columns 2–4), pres. election, and election. Firm and macroe-
conomic controls are included: market-to-book, cash flow, lt debt, st debt,
market cap, GDP, recession, and unemp. Debt expiration quintiles are
based on the percentage of debt due within the year—long-term debt due
in one year divided by the sum of long-term debt due in one year and
total long-term debt. See Appendix for variable definitions and sources.
Statistical significance at the 0.01∗∗∗ , 0.05∗∗ , and 0.1∗ level is designated
by asterisks.

all year decline. Following the election of a new gover- (1) (2) (3) (4)
nor, political uncertainty remains, and investment contin-
SEO × election −0.179∗∗ – – –
ues to decline. The third column of Table 7 includes year- (0.290)
after election observations for elections in which the in- debt issue × election – −0.084 −2.195∗∗∗ 0.419
cumbent governor is re-elected. There is no evidence of an (0.379) (0.785) (0.373)
SEO 0.265∗∗ – – –
increase in investment after these elections. This is likely
(0.132)
because the majority of these races were not uncertain debt issue – −0.253 0.946∗∗∗ −0.482∗
(see Table 1). For an increase in investment after an elec- (0.221) (0.292) (0.266)
tion to occur, the election must have been uncertain. When election 0.123 0.092 -0.057 0.106
the sample is limited to close elections won by incumbents (0.107) (0.107) (0.283) (0.138)

(column 4), there is an increase in Q1 investment, suggest- debt expiration quintile – – 1 2–5
ing that all political uncertainty caused by the election is financial controls yes yes yes yes
pres. controls yes yes yes yes
resolved by the incumbent’s re-election. macroeconomic controls yes yes yes yes
The volatility results presented in Table 5 support the state/industry/year FE yes yes yes yes
conclusion that incumbency matters to the complete res- begproj = 1 2,064 2,065 341 1,146
olution of political uncertainty. In Panel D of Table 5, af- begproj = 0 39,744 39,799 5,993 23,309
ter a close election, firms in states that have just elected no. of obs. 41,808 41,864 6,334 24,455
a previously unknown governor have higher volatility than likelihood ratio 344.57 344.71 221.56 259.39
firms in states that re-elected an incumbent. The largest
differences in volatility between firms in states that have related investments are delayed, this coefficient should be
elected a new governor and the volatility of firms in states insignificant. Since there is clustering of issuance activity
that have re-elected an incumbent is strongest from Jan- among states (see Table 3), I re-estimate results omitting
uary to April. The difference is only significant for Febru- firms headquartered in California and Texas, as 16.36% and
ary, likely due to the small sample size, which is limited as 11.77% of my SEO sample are in California and Texas, re-
incumbents are rarely involved in close elections. Any dif- spectively. The conclusions remain unchanged; the results
ferences in volatility virtually disappear by May and June. are not driven by SEOs within either state. Results for these
Perhaps not coincidentally, the higher period of volatility subsamples are presented in the online appendix.
occurs during the first 100 days in office, a period of time In columns 2 through 4 of Table 8, debtissue replaced
in which the governor and his administration are subject SEO in the estimation. In column 2, the estimation for
to close scrutiny. the whole sample, the coefficient on the interaction be-
Table 8 presents results testing whether costly financing tween debtissue and election is negative, but insignificant.
activities associated with investments are postponed be- In the whole sample, debt issuances during election years
fore elections. In the first column, I regress begproj on SEO, are no less likely than issuances during non-election years
a binary variable equal to one if a firm had an SEO that to be associated with a firm beginning an investment
year, election, an interaction between begproj and election, project.
and firm, state, and presidential election control variables. There are several possible explanations for why elec-
The coefficient of interest, on the interaction between elec- tions have a stronger effect on whether SEOs are related
tion and SEO, is negative. If a firm has an SEO in the year to the start of election-year investment projects than debt
of an election, it is approximately 3.77% less likely to begin issuances. DeAngelo, DeAngelo and Stulz (2010) find that
a project than if the firm issues equity in a non-election 99.4% of cash balances attributable to SEOs are spent in
year. Although I expected a negative coefficient on election, the year of the SEO, suggesting that firms raise capital
that firms would be less likely to begin projects in the year through SEOs intending to use the capital quickly for a spe-
of an election, the coefficient is positive and insignificant, cific purpose. Debt issuances, however, may be less likely
which may be because the majority of the effect of elec- than SEOs to be related to the beginning of an investment
tions is being picked up by the interaction between elec- project (Barclay, Fu and Smith, 2014; Dudley, 2012). For ex-
tion and SEO. If all forgone SEOs are postponed because the ample, the goal of a debt issuance may be to replace exist-
 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
ing debt due to expire. It is unclear whether an issuance
intended to replace existing debt would be delayed under
higher uncertainty, where an issuance to fund investment
should be delayed along with the start of the investment
project.
I test whether there is a relation between the begin-
ning of new investment projects and debt issuances among
firms with varying amounts of expiring debt. I partition my
sample into quintiles based on the percentage of long-term
debt due to expire within the year—long-term debt due
in one year divided by the sum of long-term debt due in
one year and total long-term debt. The average long-term
debt of firms in the lowest quintile due within the year
is approximately 0.2%. In contrast, approximately 23.9% of
long-term debt of firms in the highest four quintiles is due,
on average. I re-estimate my results on these two sam-
ples in columns 3 and 4, respectively. I find that, in the
sample with the lowest percentage of expiring debt, firms
with debt issuances in election years are 10.16% less likely
to begin a project than firms with debt issuances in non-
election years. Among firms with a higher percentage of
long-term debt expiring, which may be issuing debt to re-
place the debt that is due, the coefficient on the interac-
tion between election and debtissue is insignificant. Politi-
cal uncertainty affects whether debt issuances are related
to the start of new investment projects, but only among
firms with relatively low amounts of long-term debt due
to expire within the year.
The tests in Table 8 were designed to directly tie the
effects of political uncertainty on investment and financing
activities associated with investment. Bernanke (1983) the-
orizes that irreversible investment should be delayed in
times of greater uncertainty. If firms are postponing ir-
reversible investments, they should also postpone costly
issuances related to those investments. However, Pástor
and Veronesi (2012), Pástor and Veronesi (2013) and Kelly,
Pástor and Veronesi (2016) demonstrate how political
uncertainty can affect risk premia. Changing risk premia
may affect firms’ propensity to both begin investment
projects and issue debt or equity. The tests in Table 8 are
not designed to test whether these effects are caused by
irreversibility of investment and financing activities or
changing risk premia. Regardless of the channel driving
the effects, I demonstrate that both financing and invest-
ment activities are inversely related to increased political
uncertainty.
5.2. Robustness
5.2.1. Robustness of investment results
To ensure that the effect of political uncertainty on in-
vestment is not driven by states within one gubernatorial
election cycle, I re-estimate the DDD model on three sub-
samples of firms: firms in states with elections not coin-
ciding with the presidential elections, firms in states with
the even-year election cycle not coinciding with the presi-
dential election, and firms in states with odd-year election
cycles.21 The results for all three subsamples are similar—
21
Tables for all results discussed in the Robustness section are available
in the online appendix.
575
there is approximately a 5% decline in investment, limited
to Q3.
Each DDD model estimated in this paper regresses in-
vestment, capital expenditures scaled by total assets, on
an election variable and controls, including Tobin’s Q.
Erickson and Whited (20 0 0) discuss biases caused by mis-
measurement of Q. It is plausible that the uncertainty as-
sociated with an election could be priced into the market-
to-book ratio, resulting in an inaccurate estimate of the co-
efficient on the election variable. Therefore, I use the signs
test in Erickson and Whited (2005) to determine if mis-
measurement of Q affects my results. I find that, unless
the mis-measurement of Q is correlated with the timing of
gubernatorial elections, the minimum correlation needed
to determine that political uncertainty is associated with a
decline in investment is near zero.
I determine that my results are concentrated in firms
most susceptible to changes in political uncertainty: small
firms, firms in politically sensitive industries,22 and firms
with more costly-to-reverse investments. I find the great-
est decline in investment for the lowest quintile of size,
measured by either number of employees or total assets.
Using the asset specificity and nonspecificity metrics in
Strömberg (20 0 0), I find the strongest effect in firms with
the lowest asset nonspecificity or the highest asset speci-
ficity. The decline in investment before elections is ap-
proximately 15% for firms in politically sensitive industries.
These results are additional confirmation that my election
variable is capturing the increase in political uncertainty
associated with gubernatorial elections, rather than any
spurious correlation.
When creating election variables, firms are linked to
gubernatorial elections by their state of headquarters as
reported by Compustat. Some firms, however, have signif-
icant operations in states other than their state of head-
quarters. Boeing, for example, is officially headquartered in
Chicago, Illinois, despite being founded in Seattle, Wash-
ington, with major operations in a number of states.23 If
firms are randomly matched with incorrect states of head-
quarters, I would expect to find no effect from gubernato-
rial elections, so this would bias against my results. How-
ever, improper matching may not be random and could in-
troduce any number of biases, so I create two measures of
firm geographic concentration for robustness.
To measure firm geographic dispersion, I follow García
and Norli (2012) by counting the number of times state
names appear in 10-K statements. From these counts, I cre-
ate two variables, conc of most freq state, the number of
times the name of the most frequent state appears as a
percentage of the total number of states mentioned, and
total concentration. To calculate total concentration, I find
the total number of states mentioned and the percentage
of mentions each state comprises. Then, I square and sum
those percentages to create a Herfindahl-like measure of
state concentration. States that are more strongly concen-
22
Politically sensitive industries are defined as beer, smoke, guns, gold,
mines, coal, and oil in Kostovetsky (2015).
23
According to information provided on Boeing’s website, as of 2014,
approximately 50% of its employees are located in Washington, 11% in
California, and 9% in Missouri.
576 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
trated in one or two states will have a higher total con-
centration. For example, Firm A and Firm B both operate in
only two states. Firm A has 50% of its operations in each
state, while Firm B is more concentrated, with 75% of its
operations in one state. Firm B will have a higher total
concentration than Firm A (0.625 vs. 0.50, respectively). Ap-
proximately 55% of the time, the most frequent state men-
tioned in a firm’s 10-Ks was its state of headquarters. On
average, there were 36.75 states listed per 10-K (median
of 20). My measures are negatively correlated with three
measures of firm size: log of market capitalization, total
assets, and number of employees—small firms are more
likely to be geographically concentrated than larger firms.
I re-estimate my DDD model on geographic concentra-
tion subsamples. The pull-back in pre-election investment
is stronger for the sample that is more geographically con-
centrated, but not significantly so. The decline in invest-
ment measured for firms with high geographic concentra-
tion is significant and approximately 8.8% lower than the
decline in firm investment estimated for firms with low
geographic concentration.
5.2.2. Measuring election closeness
I measure a close election as having a vote differen-
tial (difference in percentage of votes received between the
first and second place candidates) in the lowest tercile of
sample vote differentials. This measure of election close-
ness is ex post; closeness defined by the outcome of an
election in November is used to examine investment in Q2
and Q3. Although poll data were not available for the en-
tire sample, I evaluate the appropriateness of using elec-
tion results as a measure of closeness on a smaller subset
of poll data.24 I hand-collect poll data on 1,076 polls for 53
elections that occurred between 2007 and 2010 from Real
Clear Politics. In comparison, the sample used for the anal-
yses in my paper thus far covers 24 years and 328 elec-
tions.
To measure closeness using poll data, I first calculate
the difference in percentage vote received (“poll vote dif-
ferential”) for the top two candidates in each poll. Then,
I average the poll vote differential in Q2 and Q3 for each
gubernatorial election. I focus on polls from Q2 and Q3 of
an election year, as candidates may still be entering races
and firming up platforms in the first quarter. Polls from the
fourth quarter are not used as, like election results, they
are an ex post measure of uncertainty. Approximately 53%
of the polls occur in the second or third quarter. An elec-
tion is defined as close if the election’s average poll vote
differential is in the lowest tercile of the sample of aver-
age poll vote differentials.
I re-estimate my DDD model with closeness defined us-
ing poll data rather than election outcome. The results are
virtually indistinguishable, likely due to the construction
of the closeness variable. To be defined as close, the vote
differential, whether from polls or election results, must
be below a threshold. Only a handful of elections become
more or less close in the months leading up to the elec-
tion such that their vote differential crosses that threshold;
24
Campaign donations or spending could also be used to gauge election
closeness, but were available only for the aggregate election year.
there is a correlation of 0.88 between the average poll mar-
gin and election results. These results suggests that close-
ness defined from election data is a fair measure of ex ante
election closeness.
Finally, the closeness variable could also capture effects
beyond that of political uncertainty if close elections are
more likely to occur in a state, region, time, and/or elec-
tion cycle. I examine the distribution of close elections and
find no clustering in close elections, so election closeness
should not be picking up any of these potential confound-
ing effects.
5.2.3. Testing against alternative hypotheses
I test whether political uncertainty affects firm disin-
vestment for all firms in the sample, as well as two sub-
samples particularly susceptible to political uncertainty,
small firms and politically sensitive firms. Generally, the ef-
fects of political uncertainty on disinvestment are weaker
than the effects measured for investment. In the whole
sample, I find weak evidence that disinvestment is de-
layed pre-election; the coefficient on the interaction be-
tween election and Q3 is negative, as expected, but not sig-
nificant (t-statistic of 1.48). The year-after effect is positive,
but only weakly significant (t-statistic of 1.64). In the sub-
sample of small firms, I find a significant pull-back in pre-
election disinvestment, but the post-election effect, while
positive, is insignificant. Firms in politically sensitive in-
dustries have no apparent pre-election decline in disinvest-
ment, but significantly increase their post-election disin-
vestment. These results suggest that, like investment, dis-
investment is postponed until political uncertainty is re-
solved. A decline in pre-election disinvestment is consis-
tent with the story of uncertainty, not politician or firm
manipulation, driving firm decision making around elec-
tions.
In addition to the manipulation hypotheses, there are
any number of possible explanations for changes in invest-
ment around elections. For example, governors who had
previously propped up firm investment with state policies
could be too busy campaigning to continue to support in-
vestment. Alternatively, governors who are no longer seek-
ing re-election may withdraw their support from firms
or give up trying to support investment (a “lame duck”
story). Any reduction in gubernatorial support for invest-
ment does not come from lower state subsidies to firms;
I examine both aggregate and industry state-level subsi-
dies in election years and find no significant change in
payments. This test does not, however, rule out these sto-
ries altogether, as a reduction in gubernatorial support
could be as intangible as a change in rhetoric. Although
there are many possible explanations for changes in pre-
and post-election investment, the evidence presented in
this paper—decline in investment and disinvestment be-
fore elections, subsequent rebound in both, higher volatil-
ity, etc.—all point to higher political uncertainty caused by
elections driving the results. Given the wide literature doc-
umenting the importance of uncertainty to firm decision
making and the dubious nature of some of these alterna-
tive hypotheses, it is reasonable to conclude that the ef-
fects documented in this paper are the result of political
uncertainty.
 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579 577

6. Conclusion Political variables

election binary variable equal to one if a gubernatorial
I use a DD model and term limits as an IV for elec- election occurred in that state in that year
close binary variable equal to one if the vote differential
tion closeness to establish a causal effect of political uncer-
(difference between the percentage of votes
tainty in the U.S. on firm investment. Additionally, I pro- obtained by the first and second place
vide evidence that the volatility of firms in states about candidates) for an election is in the lowest
to elect a governor is higher than the volatility of firms in sample tercile of vote differential
states in non-election years, directly linking higher political yearafter binary variable equal to one the year after a
gubernatorial election occurred in that state
uncertainty before elections to an increase in a firm-level
pres. election binary variable equal to one if a presidential
measure of uncertainty. I identify several firm characteris- election occurred in that year
tics that result in a firm being more susceptible to higher yearafter binary variable equal to one if a presidential
political uncertainty and use term limits to test against al- pres. election occurred in the previous year
termlim binary variable equal to one if the incumbent
ternative explanations for the decline in investment before
governor is prevented from seeking re-election
elections. Finally, I find that financing activities related to by term limits
investment are also postponed in times of greater political govswitch binary variable equal to one if the governor
uncertainty. changed from the previous year’s governor
The results provide some of the first empirical evidence Macroeconomic control variables
that firms within the U.S. are affected by political uncer-  GDP annual percentage change in state GDP
quarterly state unemployment rate
tainty, rather than general economic uncertainty. However,
unemployment
gubernatorial elections are only one source of political un- recession a binary variable equal to one for a quarter within
certainty within the U.S. In addition to the uncertainty an NBER-defined recession
caused by federal elections, federal regulatory bodies, such
as the Securities and Exchange Commission (SEC) or Fed-
eral Reserve, court deliberations and decisions, and legisla- Firm variable construction
tive actions also cause political uncertainty that has the
ability to influence firm decision making. In this context, The definitions and data sources for all financial vari-
finding a 5% decline in investment before only gubernato- ables are given below. All Compustat variables used in tests
rial elections gives an idea of how important politics are to with investment or disinvestment as dependent variables
firm behavior within the U.S. are defined quarterly, with the exception of asset speci-
I find that the year-after election increase in investment ficity and nonspecificity measures, which are defined us-
is dependent on whether an incumbent governor is re- ing annual data. Financial controls included in tests of firm
elected, a finding which may seem inconsistent with the financing use the same definitions, but are computed an-
year-after results found in Julio and Yook (2012), who doc- nually, using Compustat annual file data.
ument a strong, consistent bounce-back in post-election
investment. The discrepancy in results may be due to Investment and financial characteristics (Compustat)
differences in the domestic vs. international samples or Investment/ (Capital Expenditures (CAPXY)/Total Assets (ATQ))
Assets × 100
model specifications. However, it may also point to the
Disinvestment/ Sale of Property (SPPEY)/Total Assets (ATQ)
importance of political systems in the creation of polit- Assets
ical uncertainty. Roughly 75% of the sample in Julio and Employment/ Total Employees (EMP)/Total Assets (ATQ)
Yook (2012) are firms in countries with parliamentary sys- Assets
tems. Biakowski, Gottschalk and Wisniewski (2008) find Long-term Long-Term Debt Total (DLTTQ)/Total Assets (ATQ)
debt/Assets
that stock market volatility spikes around failure to form
Short-term Debt in Current Liabilities Total (DLCQ)/Total Assets
parliamentary majority. While there are similarities be- debt/Assets (ATQ)
tween parliamentary and presidential systems, there is Market-to-book (Assets Total (ATQ) + Common/Ordinary Equity
no event in a presidential system that corresponds to a (CEQQ) + Income Taxes Total (TXTQ) +
Common Shares Outstanding (CSHOQ) × Price
failure to form a parliamentary majority. The Julio and
Close (PRM))/Total Assets (ATQ)
Yook (2012) and Biakowski, Gottschalk and Wisniewski Market cap Common Shares Outstanding(CSHOQ) × Price Close
(2008) results, taken together, suggest that political uncer- (PRCM)
tainty may arise and be resolved differently in presidential Specific assets Property, Plant, and Equipment – Buildings at Cost
and parliamentary political systems. Future research may (FATE)/Total Assets (AT)
Non-specific Current Assets (ACT)/Total Assets (AT), Property,
demonstrate that firm behavior reflects these differences.
assets Plant, and Equipment – Land and
Improvements at Cost (FATP)/Total Assets (AT)
Appendix % Of retiring Long-term Debt Due in One Year (DD1)/(DD1 +
debt Long-Term Debt Total (DLTT))
Political and economic variable construction Financing (SDC Platinum)
Debt issuance binary variable equal to one in the year of a debt
issuance
The definitions for all political variables and economic
SEO binary variable equal to one in the year of a
controls are given below. GDP is from the Bureau of Eco- seasoned equity issuance
nomic Analysis (bea.gov), and unemp is from the Bureau of Pricing and volatility (CRSP)
Labor Statistics (bls.gov). I obtain election results from CQ Volatility square root of stock’s mean squared daily return
for a calendar month
Press and hand-collect term limit data.
578 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
Geographic concentration variable construction
García and Norli (2012) create measures of firm geo-
graphic dispersion by counting the number of times state
names appear in 10-K statements, obtained from the U.S.
Securities and Exchange Commission website (SEC.gov).
According to García and Norli (2012), “The structure of a
10-K filing is standardized, and the vast majority of 10-
Ks are subdivided into the same set of sections.” García
and Norli (2012) count, “. . .the occurrence of state names
in sections ‘Item 1: Business,’ ‘Item 2: Properties,’ ‘Item
6: Consolidated Financial data,’ and ‘Item 7: Management’s
Discussion and Analysis.”
I follow the procedure described in García and Norli
(2012) by counting the number of times each full state
name (not postal code abbreviation) occurs in the selected
10-K sections. However, there are a number of instances
in which counting state names may be ambiguous or mis-
leading as to where a firm is geographically located. For
example, a reference to the Mississippi River would count
as a mention of “Mississippi,” while operations along the
Mississippi River could be located in any number of states.
Therefore, I exclude a number of problematic observations
from the state counts: Washington, D.C. does not count
as Washington state; New York Stock Exchange and Bank
of New York are omitted from the New York totals; any
mention of New York, New York counts only once for New
York; and “Mississippi River,” “Ohio River,” and “Delaware
River” are excluded, as is “Kansas City,” as there is a Kansas
City in both Missouri and Kansas. Additionally, there are
a number of U.S. cities that are also state names (for ex-
ample, Indiana, Pennsylvania or Alabama, New York). There
seem to be no mentions of these cities in the 10-Ks.
From these state counts, I compute two variables to
measure firm geographic concentration. First, conc. of most
freq. state is the number of times the name of the most
frequent state appears as a percentage of the total num-
ber of states mentioned in the 10-K statement. Second, I
calculate total concentration by finding the total number of
states mentioned and the percentage of the total number
of states mentioned each state comprises. Then, I square
and sum those percentages. This creates a Herfindahl-like
index of state geographic concentration. Both measures
will be higher for firms that are more geographically cen-
tralized.
References
Abel, A.B., 1983. Optimal investment under uncertainty. The American
Economic Review 73 (1), 228–233.
Abney, G., Lauth, T.P., 1983. The governor as chief administrator. Public
Administration Review 43, 40–49.
Abney, G., Lauth, T.P., 1998. The end of executive dominance in state ap-
propriations. Public Administration Review 58, 388–394.
Alesina, A., Perotti, R., 1996. Income distribution, political instability, and
investment. European Economic Review 40 (6), 1203–1228.
Atkeson, L.R., Partin, R.W., 1995. Economic and referendum voting: a com-
parison of gubernatorial and senatorial elections. The American Polit-
ical Science Review 89, 99–107.
Baker, S.R., Bloom, N., 2013. Does uncertainty reduce growth? Using dis-
asters as natural experiments. NBER Working paper no. 19475.
Baker, S.R., Bloom, N., Davis, S.J., 2016. Measuring economic policy uncer-
tainty. Quarterly Journal of Economics 131, 1593–1636.
Bar-Ilan, A., Strange, W.C., 1996. Investment lags. The American Economic
Review 86 (3), 610–622.
Baranowski, M., Gross, D.A., 2006. Influence over state agency activities: a
test of two survey-based measures. State Politics and Policy Quarterly
6, 220–238.
Barclay, M.J., Fu, F., Smith, C.W., 2014. Rational financial management: ev-
idence from seasoned equity offerings. Unpublished working paper.
University of Rochester.
Bernanke, B.S., 1983. Irreversibility, uncertainty, and cyclical investment.
The Quarterly Journal of Economics 98 (1), 85–106.
Bertola, G., 1998. Irreversible investment. Research in Economics 52, 3–37.
Bertrand, M., Kramarz, F., Schoar, A., Thesmar, D., 2006. Politicians, firms,
and the political business cycle: evidence from France. University of
Chicago Unpublished working paper.
Bertrand, M., Schoar, A., Thesmar, D., 2007. Banking deregulation and in-
dustry structure: evidence from the French banking reforms of 1985.
The Journal of Finance 62 (2), 597–628.
Biakowski, J., Gottschalk, K., Wisniewski, T.P., 2008. Stock market volatil-
ity around national elections. Journal of Banking & Finance 32 (9),
1941–1953.
Bloom, N., 2009. The impact of uncertainty shocks. Econometrica 77,
623–685.
Bloom, N., Bond, S., Van Reenen, J., 2007. Uncertainty and investment dy-
namics. Review of Economic Studies 74 (2), 391–415.
Boutchkova, M., Doshi, H., Durnev, A., Molchanov, A., 2011. Precarious pol-
itics and return volatility. Review of Financial Studies 25, 1111–1154.
Brainard, W.C., Shoven, J.B., Weiss, L., 1980. The financial valuation of
the return to capital. Brookings Papers on Economic Activity 11 (2),
453–502.
Brudney, J.L., Hebert, F.T., 1987. State agencies and their environments: Ex-
amining the influence of important external actors. Journal of Politics
49, 186–206.
Caballero, R.J., Pindyck, R.S., 1996. Uncertainty, investment, and industry
evoluation. International Economic Review 37, 641–662.
Chen, Y.-F., Funke, M., 2003. Option value, policy uncertainty, and the for-
eign direct investment decision. HWWA HWWA discussion paper no.
234.
Colak, G., Durnev, A., Qian, Y., 2017. Political uncertainty and IPO activity:
evidence from U.S. gubernatorial elections. Journal of Financial and
Quantiative Analysis. (forthcoming)
Cole, S., 2009. Fixing market failures or fixing elections? Agricultural
credit in India. American Economic Journal: Applied Economics 1 (1),
219–250.
Cover, A.D., 1977. One good term deserves another: the advantage of in-
cumbency in congressional elections. American Journal of Political
Science 21 (3), 523–541.
DeAngelo, H., DeAngelo, L., Stulz, R.M., 2010. Seasoned equity offerings,
market timing, and the corporate lifecycle. Journal of Financal Eco-
nomics 95, 275–295.
DeAngelo, H., DeAngelo, L., Whited, T.M., 2011. Capital structure dyanam-
ics and transitory debt. Journal of Financial Economics 99, 235–261.
Dinc, I.S., 2005. Politicians and banks: political influences on governmen-
t-owned banks in emerging markets. Journal of Financial Economics
77 (2), 453–479.
Dixit, A., 1989. Entry and exit decisions under uncertainty. Journal of Po-
litical Economy 97 (3), 620–638.
Do, Q.-A., Lee, Y.-T., Nguyen, B.D., 2015. Political connections and firm
value: evidence from the regression discontinuity design of close gu-
bernatorial elections. Shanghai University of Finance and Economics
Unpublished working paper.
Drazen, A., 2001. The political business cycle after 25 years. NBER Macroe-
conomics Annual 20 0 0, vol. 15. MIT Press, pp. 75–138.
Dudley, E., 2012. Capital structure and large investment projects. Journal
of Corporate Finance 18, 1168–1192.
Erickson, T., Whited, T.M., 20 0 0. Measurement error and the relationship
between investment and q. The Journal of Political Economy 108 (5),
1027–1057.
Erickson, T., Whited, T.M., 2005. Proxy-quality thresholds: theory and ap-
plications. Finance Research Letters 2, 131–151.
Faccio, M., 2006. Politically connected firms. American Economic Review
96, 369–386.
Faccio, M., Masulis, R.W., McConnell, J.J., 2006. Political connections and
corporate bailouts. The Journal of Finance 61 (6), 2597–2635.
Gao, P., Qi, Y., 2013. Political uncertainty and public financing costs: evi-
dence from U.S. gubernatorial elections and municipal bond market.
Unpublished working paper. University of Notre Dame.
García, D., Norli, O., 2012. Geographic dispersion and stock returns. Journal
of Financial Economics 106 (3), 547–565.
Goodell, J.W., Vahamaa, S., 2013. U.S. presidential elections and implied
volatility: the role of political uncertainty. Journal of Banking and Fi-
nance 37, 1108–1117.
 C.E. Jens / Journal of Financial Economics 124 (2017) 563–579
Gulen, H., Ion, M., 2016. Policy uncertainty and corporate investment. Re-
view of Financial Studies 29, 523–564.
Hartman, R., 1972. The effects of price and cost uncertainty on invest-
ment. Journal of Economic Theory 5 (2), 258–266.
Hartman, R., 1976. Factor demand with output price uncertainty. The
American Economic Review 66 (4), 675–681.
Hebert, F.T., Brudney, J.L., Wright, D.S., 1983. Gubernatorial influence and
state bureaucracy. American Politics Quarterly 11, 243–264.
Hurn, A.S., Wright, R.E., 1994. Geology or economics? Testing models of ir-
reversible investment using North Sea oil data. The Economic Journal
104 (423), 363–371.
Julio, B., Yook, Y., 2012. Political uncertainty and corporate investment cy-
cles. The Journal of Finance 67 (1), 45–84.
Kelleher, C.A., Yackee, S.W., 2006. Who’s whispering in your ear? Measur-
ing the influence of third parties over state agency decisions. Political
Research Quarterly 59, 629–643.
Kelly, B.T., Pástor, L., Veronesi, P., 2016. The price of political uncertainty:
theory and evidence from the option market. Journal of Finance 71,
2417–2480.
Kostovetsky, L., 2015. Political capital and moral hazard. Journal of Finan-
cial Economics 116, 144–159.
Leahy, J.V., 1993. Investment in competitive equilibrium: the optimal-
ity of myopic behavior. The Quarterly Journal of Economics 108 (4),
1105–1133.
Leahy, J.V., Whited, T.M., 1996. The effect of uncertainty on investment:
some stylized facts. Journal of Money, Credit and Banking 28 (1),
64–83.
Nordhaus, W.D., 1975. The political business cycle. The Review of Eco-
nomic Studies 42 (2), 169–190.
Oi, W.Y., 1961. The desirability of price instability under perfect competi-
tion. Econometrica 29 (1), 58–64.
579
Pástor, L., Veronesi, P., 2012. Uncertainty about government policy and
stock prices. Journal of Finance 67, 1219–1264.
Pástor, L., Veronesi, P., 2013. Political uncertainty and risk premia. Journal
of Financial Economics 110, 520–545.
Pindyck, R.S., 1991. Irreversibility, uncertainty, and investment. Journal of
Economic Literature 29, 1110–1148.
Pindyck, R.S., Solimano, A., 1993. Economic instability and aggregate
investment. NBER Macroeconomics Annual 1993, 8. MIT Press,
pp. 259–318.
Roberts, K., Weitzman, M.L., 1981. Funding criteria for research, develop-
ment, and exploration projects. Econometrica 49 (5), 1261–1288.
Roberts, M.R., Whited, T., 2012. Endogeneity in empirical corporate fi-
nance. In: Constantinidies, G., Harris, M., Stulz, R. (Eds.), Handbook
of the Economics of Finance, vol. 2. Elsevier, pp. 493–572.
Shin, H.-H., Kim, Y.H., 2002. Agency costs and efficiency of business cap-
ital investment: evidence from quarterly capital expenditures. Journal
of Corporate Finance 8 (2), 139–158.
Sigelman, L., Dometrius, N.C., 1988. Governors as chief administrators: the
linkage between formal powers and informal influence. American Pol-
itics Quarterly 16, 157–170.
Stein, L.C.D., Stone, E.C., 2013. The effect of uncertainty on investment,
hiring, and R&D: causal evidence from equity options. Unpublished
working paper. Stanford University.
Strömberg, P., 20 0 0. Conflicts of interest and market illiquidity in
bankruptcy auctions: theory and tests. The Journal of Finance 55 (6),
2641–2692.
Van Dunk, E., 1997. Challenger quality in state legislative elections. Politi-
cal Research Quarterly 50, 793–807.
Wright, D.S., 1967. Executive leadership in state administration. Midwest
Journal of Political Science 11, 1–26.