I use a difference-in-difference model to study the effects of political uncertainty on firm investment. I find that the investment of firms in states with a gubernatorial election in the next quarter is 4.5% lower than the investment of firms in states without an upcoming gubernatorial election. This effect is greater for closer elections, smaller firms, firms with greater asset specificity, firms with higher levels of potential investment, and politically sensitive firms. Additionally, the idiosyncratic volatility of firms in states with a gubernatorial election in the next quarter is 1.17% higher than the idiosyncratic volatility of firms in states without upcoming gubernatorial elections, demonstrating a clear link between an increase in firm uncertainty and the pull-back in investment. Post-election investment is 4.3% higher for these firms relative to the investment of firms in states that did not just elect a governor. Using day-after election excess stock returns as a firm-level measure of political sensitivity, I find that politically sensitive firms do not make up the foregone investment, suggesting a cost of political uncertainty to politically sensitive firms. Finally, I use term limits to test against alternative explanations for changes in investment around elections and as an instrumental variable to address the endogeneity in measuring close elections.
From the new working paper "Investment Around U.S. Gubernatorial Elections" by Candace Jens (November 2012).