We examine whether firms’ political hedging activities are effective at mitigating political risk. Focusing on the risk induced by partisan politics, we measure political hedging as the degree to which firms’ political connections are balanced across Republican and Democratic candidates. We find that greater political hedging is associated with reduced stock return volatility, particularly during periods of higher policy uncertainty. Similarly, greater political hedging is associated with reduced crash risk, investment volatility, and earnings volatility. Moreover, the reduction in earnings volatility appears to relate to both a firm’s taxes and its operating activities, as we find that greater political hedging is associated with reduced cash effective tax rate volatility and pretax income volatility. We further find investors are better able to anticipate future earnings for firms that engage in political hedging, suggesting that political hedging helps improve firms’ information environments. Lastly, we perform an event study using President Obama’s Clean Power Plan. We find that on the days this policy proposal was debated in Congress, energy and utility firms experienced heightened intraday return volatility (relative to other firms and nonevent days). However, this heightened volatility is mitigated for energy and utility firms that are more politically hedged. Overall, we conclude that political hedging is an effective risk management tool that helps mitigate firm risk. This paper was accepted by Suraj Srinivasan, accounting.
This article examines whether managers’ political orientation, which reflects their risk preferences, is associated with firms’ stock price crash risk. We find that stock price crash risk is lower when corporate managers have more conservative political ideologies, and the results are robust to controls for other determinants of crash risk. We use Heckman two-stage model and employ difference-in-differences research design around executive turnovers to show that our results are not simply driven by potential endogeneity. We also document that the relation between managerial political orientation and stock price crash risk is stronger when external monitoring is weaker. JEL Classifications: G12; G14; M41.
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