News Archive
Finance Professor Researches Connections Between the Stock Market and Presidential Power
By Keith Morelli
TAMPA (August 31, 2021) -- Looking for new ways to invest in the stock market? Consider presidential power and political geography.
While there is a positive effect of political connections in corporate performance and stock returns, a new study co-authored a USF finance professor has concluded that the positive effect diminishes in a 鈥渨eak presidency period.
鈥淧residential Power and Stock Returns鈥� is a paper written by Jung Chul Park, the Bank of America Professor with the Muma College of Business鈥檚 Kate Tiedemann School of Business and Finance, and Youngsoo Kim, a professor with the University of Regina in Saskatchewan, Canada. The paper is forthcoming in Financial Management.
鈥淭he study provides evidence that firms located in areas where state politicians are closely aligned with the president achieve higher stock returns, but only when the president is in power,鈥� Park said. 鈥淥ur findings are relevant to a diverse pool of practitioners.
鈥淔or example, investors can use our findings to devise portfolios by processing value-relevant political information,鈥� he said. 鈥淪ecurity analysts can enhance their earnings forecasts and recommendations by incorporating the effects of political geography in their analysis.鈥�
The study, he said, stops short of recommending investors sell stocks during lame duck presidencies.
鈥淥ur results imply that weak presidency mitigates the positive value effect of state political alignment with the president,鈥� he said. 鈥淚nvestors need to be careful in trading such small-sized firms without adequate political investments. We find that the degree of control of Congress by the presidential party is not the main reason behind our weak presidency results.鈥�
The researchers revisited earlier studies that found superior stock performances in the areas where state politicians are tightly aligned with the incumbent president鈥檚 party, Park said.
鈥淚n this new research, we show that the positive effect on stock returns becomes substantially weaker in the weak presidency (lame duck) period,鈥� he said. 鈥淎fter establishing the weak presidency effect, we focus on answering the following questions: How does this effect manifest? What are interesting firm characteristics related to the weak presidency effect? What would be the trade-off between direct political investment and indirect, passive political alignment?
鈥淲e provide evidence that the weak presidency effect is more pronounced for small firms and firms without direct political investment,鈥� he said, 鈥渂ecause they typically do not have enough financial resources and connections to reduce political risks.鈥�
What is a weak presidential period? For the purpose of the research, it was defined as the last two years before presidential change or period of low job approval ratings. The paper considers two hypotheses, political interconnectedness and political risk, 鈥渁nd (we) find that both hypotheses are important in explaining the weak presidency effect on stock returns, political benefits and research and development and capital expenditure,鈥� the paper鈥檚 abstract says.
鈥淭here is a trade-off between direct political investment and passive political alignment,鈥� the paper says. 鈥淔irms with direct political investment tend to hedge political risk so that they can run their real-side investment on their own schedule.
鈥淐onsistent with this story,鈥� the paper says, 鈥渨e find that the weak presidency effect is more pronounced for small firms that lack the resources for direct political investment.鈥�
Politics matters in business
The U.S. political map shifts every two years, Park said, 鈥渞eflecting changes in a firm鈥檚 capability to derive potential benefits from political connections and changes in policy risk arising from legislative activities.鈥�
The paper cites recent studies in political science and political economy that highlight an important role the president plays in shaping economic policies and federal expenditure distribution.
鈥淕iven the importance of a president in politics, the presidency should matter in business as well,鈥� the paper says. 鈥淵et, there are not many studies that have examined this issue, at least in developed markets.鈥�
This research fills this gap, Park said, finding among other conclusions, that a 鈥渨eak presidency substantially mitigates the positive value of political connections, and therefore, the power of the presidency does matter.鈥�
Park said in general, the political effects on stock markets are pervasive in the first-term presidencies, which means investors may benefit from investing in firms in states where the political majority reflects the president鈥檚 party.
Park and Kim use the Political Alignment Index, which measures at state levels the degree of alignment of politicians (senators, congressmen, governor, state senators and state congressmen) with a presidential party. The index鈥檚 positive effects on stock returns becomes substantially weaker in the weak presidency period.
鈥淭he weak presidency effect could be spurious, driven by changes in political climates other than presidential power,鈥� the paper says. 鈥淔or instance, the degree of control of Congress by the presidential party could be a factor. We examine this possibility and find that the presidential party's control of Congress does not drive our result.
鈥淲e also find that our result remains qualitatively the same when we use job approval ratings as a proxy for presidential power.鈥�