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

Anne Duquerroy ()

Working papers from Banque de France

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.

Keywords: : Investment; Checks and balances; Divided government; Gubernatorial elections; Political uncertainty. (search for similar items in EconPapers)
JEL-codes: E22 E66 G18 G31 G38 H75 (search for similar items in EconPapers)
Pages: 77 pages
Date: 2019
New Economics Papers: this item is included in nep-mac
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Persistent link: https://EconPapers.repec.org/RePEc:bfr:banfra:735

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