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 “weak presidency period.
“Presidential Power and Stock Returns” is a paper written by Jung Chul Park, the Bank of America Professor with the Muma College of Business’s 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.
“The 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,” Park said. “Our findings are relevant to a diverse pool of practitioners.
“For example, investors can use our findings to devise portfolios by processing value-relevant political information,” he said. “Security analysts can enhance their earnings forecasts and recommendations by incorporating the effects of political geography in their analysis.”
The study, he said, stops short of recommending investors sell stocks during lame duck presidencies.
“Our results imply that weak presidency mitigates the positive value effect of state political alignment with the president,” he said. “Investors 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.”
The researchers revisited earlier studies that found superior stock performances in the areas where state politicians are tightly aligned with the incumbent president’s party, Park said.
“In this new research, we show that the positive effect on stock returns becomes substantially weaker in the weak presidency (lame duck) period,” he said. “After 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?
“We provide evidence that the weak presidency effect is more pronounced for small firms and firms without direct political investment,” he said, “because they typically do not have enough financial resources and connections to reduce political risks.”
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, “and (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,” the paper’s abstract says.
“There is a trade-off between direct political investment and passive political alignment,” the paper says. “Firms with direct political investment tend to hedge political risk so that they can run their real-side investment on their own schedule.
“Consistent with this story,” the paper says, “we find that the weak presidency effect is more pronounced for small firms that lack the resources for direct political investment.”
Politics matters in business
The U.S. political map shifts every two years, Park said, “reflecting changes in a firm’s capability to derive potential benefits from political connections and changes in policy risk arising from legislative activities.”
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.
“Given the importance of a president in politics, the presidency should matter in business as well,” the paper says. “Yet, there are not many studies that have examined this issue, at least in developed markets.”
This research fills this gap, Park said, finding among other conclusions, that a “weak presidency substantially mitigates the positive value of political connections, and therefore, the power of the presidency does matter.”
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’s 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’s positive effects on stock returns becomes substantially weaker in the weak presidency period.
“The weak presidency effect could be spurious, driven by changes in political climates other than presidential power,” the paper says. “For 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.
“We also find that our result remains qualitatively the same when we use job approval ratings as a proxy for presidential power.”