Firm-level political uncertainty, corporate lobbying and risk-taking

The paper explores the impact of firm-level political uncertainty on corporate risk-taking, a topic of increasing relevance given recent global political tensions. While existing research demonstrates that political uncertainty negatively affects various economic and firm outcomes, the specific relationship with firm-level risk-taking remains unclear. Some studies suggest that increased political uncertainty leads to reduced risk-taking due to heightened information asymmetry and increased external financing costs. Conversely, other research posits that firms facing high political uncertainty may engage more in lobbying to gain access to policymakers and private information, potentially leading to increased risk-taking. This paper aims to address this ambiguity by empirically examining the relationship between firm-level political uncertainty and corporate risk-taking, considering the moderating role of corporate lobbying.

The literature review examines existing research on the effects of political uncertainty on firm behavior. Studies have shown that aggregate political uncertainty leads to increased default risk, reduced employment and production, and decreased corporate investment and innovation. Some research suggests a negative relationship between political uncertainty and corporate risk-taking, attributing this to increased information asymmetry and financing costs, which leads to managerial conservatism. However, other studies suggest a potential positive relationship, arguing that firms may engage in lobbying to mitigate uncertainty and gain an informational advantage, thereby increasing their willingness to take risks. The lack of consensus regarding the direction of this relationship motivates the present study's empirical investigation.

The study utilizes a sample of 32,695 firm-year observations of non-financial U.S. firms from 2002 to 2021. Firm-level political uncertainty is measured using a novel proxy developed by Hassan et al. (2019), based on the proportion of quarterly earnings conference calls devoted to discussing political risk. This proxy utilizes a machine learning algorithm to analyze transcripts of these calls. Corporate risk-taking is measured using several alternative proxies, including the standard deviation of return on assets (ROA) relative to the industry average, the volatility of earnings before interest, taxes, depreciation, and amortization (EBITDA), and the standard deviation of ROA and EBIT. The authors control for several firm-level characteristics (size, tangibility, leverage, Tobin's Q, cash-to-assets ratio, Z-score, firm age, loss), as well as macroeconomic variables (GDP per capita, inflation, unemployment). Industry fixed effects are included, and standard errors are clustered by firm. To address potential endogeneity concerns, a propensity score matching (PSM) approach is also employed, comparing firms with high and low political uncertainty levels while controlling for other relevant characteristics.

The main empirical analysis reveals a significant positive relationship between firm-level political uncertainty and corporate risk-taking. A one-standard deviation increase in firm-level political uncertainty leads to a 2.53% increase in risk-taking. This positive association is robust across various measures of risk-taking and remains significant after controlling for firm characteristics and macroeconomic factors. The study further shows that the impact of firm-level political uncertainty on risk-taking is stronger for firms with higher lobbying expenditures. Subsample analysis indicates that this effect is more pronounced for larger firms and in the period following the 2008 financial crisis. Topic-specific analysis shows a positive association between risk-taking and political uncertainty across several policy areas, including economic policy, budget, institutions, healthcare, security, taxation, and technology. Propensity score matching confirms the robustness of the positive relationship between firm-level political uncertainty and risk-taking, mitigating concerns about endogeneity.

The findings challenge the conventional wisdom that political uncertainty always leads to reduced risk-taking. The study demonstrates that firm-level political uncertainty, particularly when coupled with active lobbying, can incentivize greater risk-taking. This suggests that firms may leverage political connections and access to information to manage and even exploit the uncertainties in the political environment. The results highlight the importance of considering firm-level heterogeneity in responses to political uncertainty. Larger firms, likely possessing greater resources and expertise, may be better positioned to navigate the complexities of political risk and benefit from strategic risk-taking in this context. The heightened sensitivity after the 2008 financial crisis suggests that periods of macroeconomic instability can exacerbate the impact of firm-level political uncertainty on corporate risk-taking decisions.

This study contributes to the literature by demonstrating a positive relationship between firm-level political uncertainty and corporate risk-taking, particularly for larger firms engaging in lobbying activities. The findings highlight the importance of analyzing political risk at the firm-level rather than solely at the aggregate level, showing that firm-specific responses are nuanced and can deviate from macroeconomic trends. Future research could explore more granular measures of political uncertainty, examining the specific policy areas impacting firm decisions, and expand the geographic scope beyond the U.S. to capture diverse political systems and firm behaviors.

The study's limitations include the reliance on ex-post measures of risk-taking, which might not fully capture ex-ante managerial decisions. The sample is confined to U.S. firms, limiting generalizability to other countries with different political and institutional settings. Further research should consider ex-ante risk measures and expand the geographic scope to include a wider range of political contexts.