27 Feb 2012
Research shows political uncertainty fuels caution Companies may cut their investments as the US presidential election gets closer or when there is political jostling, according to a London Business School expert.
Brandon Julio, assistant professor of finance at the School, predicts that political uncertainty will play an important role in corporate investment decisions.
To explore this issue, Dr Julio and co-author Youngsuk Yook of Korea’s Sungkyunkwan University examined the investment behaviour of firms around national elections. They found that the impact of uncertainty is stronger in countries with higher levels of national debt and at times when there is potential for large changes in government policy.
More specifically, they find that firms invest less in capital expenditures, such as building new factories and buying equipment, when the political outcomes are unclear.
In light of the ongoing financial crisis, uncertainty over how countries will change regulatory policy is stalling large new projects, which in turn slows the rate of economic recovery. This rings true in the US, where companies such as American Airlines are feeling harsh effects – recently announcing its plan to decrease spending across the board by 20 percent.
The authors raise the question: does political uncertainty lead firms to invest less, or does slower economic growth generate uncertainty in the first place?
“Focusing on the timing of national elections allows us to observe fluctuations in political uncertainty that are unrelated to economic conditions and therefore isolate the effects of policy uncertainty on investment,” explains Dr Julio.
“When mistakes are costly, it makes economic sense for firms to wait until they have a stronger grasp on how government policy will be shaped. Corporate investment is very sensitive to uncertainty, so even small expected shifts in policy can lead firms to cut back on investment. As such, cycles in corporate investment around election dates occur even in relatively stable democracies. Our findings suggest that the election in the US and many other countries around the world may slow the recovery from the recent recession.”
The study was published in the February 2012 issue of the Journal of Finance.
To read the study in detail, access the full report here http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2011.01707.x/pdf