Does local political support influence financial markets? A study on the impact of job approval ratings of political representatives on local stock returns

• Date: 01 May 2020
• DOI: http://doi.org/10.1111/fire.12211
• Author: Dong H. Kim,Jung Chul Park,Sunghoon Joo
• Published date: 01 May 2020

DOI: 10.1111/fire.12211

ORIGINAL ARTICLE

Does local political support influence financial

markets? A study on the impact of job approval

ratings of political representatives on local stock

returns

Sunghoon Joo1Dong H. Kim2Jung Chul Park3

1College of Business Administration and Public

Policy,California State University Dominguez

Hills, Carson, California

2DickeCollege of Business Administration, Ohio

Northern University, Ada, Ohio

3Muma College of Business, University of South

Florida, Tampa,Florida

Correspondence

DongH. Kim, Dicke College of Business Adminis-

tration,Ohio Northern University, DickeHall 126,

525S. Main Street, Ada OH 45810.

Email:d-kim@onu.edu

Abstract

Using data on job approval ratings of governors, U.S. senators, and

the president, we find that firms located in states with high approval

ratings outperform firms located in states with low approval ratings

by .64% per month. Furthermore, this relationship is stronger when

investors are actively involved in politics, when local politicians are

closer to the center of political power, for small firms that have a

larger proportion of local investors, and for financially strong areas

where investors are ready to execute investments in local stocks.

Overall, our study shows that investors’political sentiment is impor-

tant in determining stock returns.

KEYWORDS

job approval ratings, performance, political sentiment, returns

JEL CLASSIFICATIONS

G11, G14, G18

1INTRODUCTION

The body of literature linking politics and financial markets attracts a great deal of attention. A majority of studies in

this literature focus on the effects of direct political connections on firms’ operational performance and stock returns.

Firms implement various active political strategies by making significant contributions to political campaigns (Cooper,

Gulen, & Ovtchinnikov, 2010), adding former politicians to their boards of directors (Goldman,Rocholl, & So, 2009,

2013), and expanding their lobbying activities (Hill, Kelly, Lockhart, & Van Ness, 2013). Responding to this field of

knowledge, researchers find that political connections can provide firms access to cheaper financing through equity

(Boubakri, Guedhami, Mishra,& Saffar, 2012), public debt (Bradley,Pantzalis, & Yuan, 2016), and bank loans (Claessens,

Feijen, & Laeven, 2008; Houston, Jiang, Lin, & Ma, 2014), as well as through initial public offerings (Francis,Hasan, &

Sun, 2009). Moreover,political connections can affect corporate financial strategies, such as mergers and acquisitions

(Ettore, Pantzalis, Park,& Petmeza, 2017).

Financial Review.2020;55:247–276. wileyonlinelibrary.com/journal/fire c

2019 The Eastern Finance Association 247

248 JOO ET AL.

FIGURE 1 Job approval ratings and stock returns

Note: This graph presents the president’s averagejob approval ratings and value-weighted market returns from 1981

to 2009.

We investigate whether investor’s political sentiment can account for aspects of the local economy.More specifi-

cally, we are interested in if and how political support from investors,as indicated by Job Approval Ratings (JARs here-

after), correlates with local stock returns. Political sentiment and stock marketperformance appear to be interrelated.

As we show in Figure 1, the president’s averagejob approval ratings and value-weighted market returns fluctuate over

time in similar patterns.

Our paper might be closely related to a recent study by Addoum and Kumar (2016), who highlight the crucial effect

of political sentiment on financial markets. Determining the degree of industry sensitivity to the presidential election

outcome, they show that politically favoredindustries earn higher returns. Furthermore, investors’ relative holdings of

Republican- versus Democrat-favoredindustries change as the party in power shifts in favor of those industries. Their

results are consistent with the view that investors increase their investments in politically favored stocks when the

party in power changes because they believe that the political change will result in higher returns for these stocks. We

propose that investors who are favorablydisposed toward their political representatives can influence stocks in their

local areas, due to their excessivepenchant for local stocks.

By using unique and comprehensive data on state-level JARs, we uncover evidence that institutional investorshave

biased holdings of local stocks in the areas with high political sentiment. We then explore whether investors’political

mood affects local firms’ valuation. Wemeasure a variable at the state level monthly by averaging JARs of the president,

governors,and U.S. senators to investigate the impact of JARs on local firms’ stock returns. We conjecture that investors

in states where residents are more supportive of their politicians are more optimistic about the local economy,which

makes them more likelyto increase their holdings of local firms’ stocks. Therefore, we expect that firms in states with

strong political sentiment perform better than firms in states where local residents are less favorablydisposed toward

their political representatives.

We document the effect of investor approval of their politicians on local stock returns. Wefind that firms in states

where local investors tend to strongly support their local politicians and the president perform better than firms in

states where local investors do not support their local politicians. The difference in mean returns between the top and

bottom terciles is 64 basis points per month, which is statistically significant at the .01 level. We confirm this finding in

the cross-sectional regression that controls for conventionalrisk factors such as size, value, beta, and previous returns,

among others, along with time, state, and industry fixed effects.