Foreign Risk, Domestic Problem: Capital Allocation and Firm Performance Under Political Instability

Burcin Col (), Art Durnev () and Alexander Molchanov ()
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Burcin Col: Lubin School of Business, Pace University, New York, New York 10038
Art Durnev: Henrie B. Tippie College of Business, University of Iowa, Iowa City, Iowa 52242
Alexander Molchanov: School of Economics and Finance, Massey University, North Shore, Auckland 0745, New Zealand

Management Science, 2018, vol. 64, issue 5, 2102-2125

Abstract: We argue in this paper that firms with foreign operations misallocate capital and underperform when they face political instability abroad. We develop and test a dynamic model of firm capital allocation under foreign political instability. The model shows that as a political regime becomes less stable, independent of whether the regime becomes less business-friendly or more business-friendly, firms invest suboptimally (i.e., they either overinvest or underinvest), and their marginal q ’s diverge further from an optimal level. Using elections and textual analysis of local media during national elections, we construct a novel index of political instability. We find that U.S. firms and industries with a greater exposure to election-induced political instability experience disruptions of investment efficiency that lead to lower valuations and lower total factor productivity. Therefore, international trade is a significant conduit of foreign political instability into U.S. markets.

Keywords: political instability; foreign operations; investment efficiency (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (8)

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