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The Real Effects of Checks and Balances: Policy Uncertainty and Corporate Investment

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  • Anne Duquerroy

Abstract

This article explores the economic effects of checks and balances on corporate investment and employment. I use U.S. gubernatorial election results from 1978 to 2010 as a source of exogenous variation in whether the party controls both the executive and the legislative branch (unified government) or not (divided government), which determines its ability to implement its political agenda. I find that both public and private firms respond to the political cycle by reducing investment and hiring when government becomes unified. Investment drops by three to five percent in the year following an election resulting in unified government, while stock returns volatility is three percent higher. The findings support the hypothesis that moving from divided to unified government raises policy uncertainty by increasing the probability of future policy changes. Consistent with a real option channel, the effect is stronger for capital intensive firms with lower asset redeployability.

Suggested Citation

  • Anne Duquerroy, 2019. "The Real Effects of Checks and Balances: Policy Uncertainty and Corporate Investment," Working papers 735, Banque de France.
    • Handle: RePEc:bfr:banfra:735
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    : Investment; Checks and balances; Divided government; Gubernatorial elections; Political uncertainty.;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E66 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General Outlook and Conditions
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • H75 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Government: Health, Education, and Welfare

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