Governmental unity and corporate performance

• Published date: 01 October 2022
• Author: Mengyao Cheng
• Date: 01 October 2022
• DOI: http://doi.org/10.1002/jcaf.22565

Received: 3 February 2022 Revised: 3 May 2022 Accepted:4May2022

DOI: 10.1002/jcaf.22565

RESEARCH ARTICLE

Governmental unity and corporate performance

Mengyao Cheng

Sawyer Business School, Suffolk

University, Boston, Massachusetts, USA

Correspondence

Mengyao Cheng, Sawyer Business School,

Suffolk University, Boston, MA, USA.

Email: mcheng4@suffolk.edu

Abstract

This paper examines the impact of governmental unity on corporate perfor-

mance. Calendar years are classified as united when the president, Senate major-

ity,and House majority are all from the same political party. Results indicate that

firms have higher accounting return on assets when the federal government is

united than when it is not. Firms have higher accounting return on assets when

federal and state governments are both united under the same party,though the

structures of federal and state governments may differ in the same time episode.

The positive effect of government unity on corporate performance is stronger

when the firm’s sales growth rate is greater and profitability more volatile. The

results are consistent with united government promoting legislation efficiency

and reducing uncertainty in political environments.

KEYWORDS

corporate performance, government unity, policy uncertainty

1 INTRODUCTION

This paper examines the impact of governmental unity on

corporate performance. The legislative body of the United

States, the Congress, is composed of two chambers – the

House of Representatives (House) and the Senate. For a

bill to pass, it must pass in both chambers before it could

be signed into law by the President of the United States. As

a result, the legislative branch of the government is effec-

tively a 3-stage process. To add to the structure, the Presi-

dent, as well as each member of Congress, belongs to one of

two political parties – the Democratic Party or the Repub-

lican Party.1If the House majority, Senate majority, and

President all belong to the same political party,the govern-

ment is defined as “united” in this paper. Otherwise, the

government is defined as “divided.” Examining the differ-

ences in corporate performance under the two regimes can

help shed light on the efficiency of government and how

that efficiency translates into a better financial operating

environment for firms.

Prior literature suggests that the political environment

has implications for corporate performance. The ele-

ments of the political environment studied include polit-

ical uncertainty surrounding presidential elections, politi-

cal spending, political rights, and political geography (e.g.,

Belo et al., 2013; Kim et al., 2012;Qietal.,2010). These stud-

ies find that firms’ decisions are influenced by the larger

political environment that they operate in. In particular,

prior studies of policy uncertainty have established that by

changing investors’ and managers’ risk perceptions, policy

uncertainty not only affects asset pricing, but also affects

corporate investment and financing activities (e.g., Bro-

gaard & Detzel, 2015; Brogaard et al., 2020; Chan et al.,

2021; Çolak et al. 2017; Gulen & Ion, 2016;Jens,2017;Julio

& Yook, 2012;Pastor&Veronesi,2012, 2013). As higher

policy uncertainty leads to reduced and slowed corpo-

rate investment, lowered investment efficiency, increased

external financing costs, as well as decreased consumption

expenditures, it is likely that policy uncertainty affects cor-

porate performance (Davis, 2019; Eberly, 1994; Giavazzi &

McMahon, 2012; Gozgor & Demir, 2018).

Prior studies also suggest that government structure

affects policymaking. Given partisan preferences, the

makeup of Congress and the interaction betweenCongress

92 © 2022 Wiley Periodicals LLC. J Corp Account Finance. 2022;33:92–108.wileyonlinelibrary.com/journal/jcaf

CHENG 93

and the President determines the passage as well as the

timing and ultimate content of laws. If the federal gov-

ernment is united, the legislation process is less likely to

be contested and delayed, making it less difficult and less

time consuming to pass bills. As a result, a united gov-

ernment is likely to have greater legislation efficiency and

lower policy uncertainty.However, a united government is

more likely to pass laws that bring fundamental changes,

creating greater policy uncertainty. The political science

literature focuses on the effects of divided versus unified

government on legislation but documents mixed evidence

regarding legislative productivity,paying little attention to

policy uncertainty (e.g., Coleman, 1999; Howell et al., 2000;

Hughes & Carlson, 2015; Mayhew, 1991).

In short, the literature provides little empirical evidence

on the relation between federal government unity and

corporate performance. Because government unity can

possibly increase or decrease policy uncertainty, which, in

turn, may affect corporate actions, this relation remains

to be tested. To empirically examine the effect of federal

government unity, I use a sample of 10,551 non-financial

firms, with 138,807 firm-year observations over 1952–2019,

representing 49 states and 44 of the Fama-French 48

industries. I first empirically test the association between

federal government unity and policy uncertainty and

find the association to be negative, indicating that policy

uncertainty is lower under a united government. I then

test the effect of government unity on corporate perfor-

mance. The results indicate that when federal government

is united, corporate accounting return on assets (ROA) is

significantly greater than when the government is divided.

The difference in ROA between the two types of federal

governments is about 12.5% of the median ROA of the

sample.

While federal government is relatively exogenous to cor-

porate performance, it is possible that better corporate per-

formance could be driven by government unity coincid-

ing with “good times,” though my regressions control for

macroeconomic indicators such as buy-and-hold returns

of value-weighted market portfolio over the current year

and over the previous year, government budget deficits,

as well as economy recession. To address this issue, I uti-

lize the fact that state government structure may exhibit

variations during the same time episode and conjecture

that state government structure may moderate the effect

of federal government unity.I find that after controlling for

federal and state government structures, corporate perfor-

mance is significantly greater when federal and state gov-

ernments are both united under the same party. I also find

some evidence that corporate performance is weakerwhen

federal and state governments are both united, but under

different parties. These results are inconsistent with fed-

eral government unity purely reflecting nation-wide “good

times,” because “good times” so defined apply across states

while state government unity differs across states.

Furthermore, the results indicate that government unity

has a greater effect on corporate ROAfor firms with greater

growth opportunities and greater profit volatility, consis-

tent with the effect of government structures depending

on firm characteristics (Belo et al., 2013; Kim et al., 2012).

The positive effect of federal government unity also holds

for alternative corporate performance measures including

accounting return on equity,and corporate stock buy-and-

hold returns. Meanwhile, the results show that firms have

lower stock volatilities when federal government is united

than when it is not.

Overall, this study documents that federal government

unity increases corporate performance, likely through

reducing uncertainty in the political environment. This

paper contributes to the emerging literature on the rela-

tionship between political factors and firm performance.

The body of literature examines how the political environ-

ment in which firms reside affect firm performance, and

this paper shows that firms, and the economy as a whole,

are impacted by whether or not the government is united

or divided. In fact, the results imply that the law making

process creates lower uncertainty under a united regime.

In particular, this study adds to two lines of prior studies

by documenting the effect of federal government unity on

policy uncertainty and on corporate performance. The first

line of studies focuses on the effect of united versus divided

government on legislation, providing little evidence on the

relation between government unity and political uncer-

tainty (e.g., Coleman, 1999; Howell et al., 2000; Hughes &

Carlson, 2015; Mayhew, 1991). The second line of studies

focuses on implications of policy uncertainty for corporate

activities such as external financing and investments, but

the studies do not examine comprehensive corporate per-

formance as reflected in ROA (e.g., Brogaard et al., 2020;

Chan et al., 2021; Çolak et al., 2017; Gulen & Ion, 2016;Julio

& Yook, 2012).

The rest of the paper is organized as follows: Section 2

reviews the literature and develops the hypothesis. Sec-

tion 3describes the sample and data and presents descrip-

tive statistics. Section 4presents empirical analyses and

results, and Section 5concludes.

2LITERATURE REVIEW AND

HYPOTHESIS DEVELOPMENT

2.1 Government unity and policy

uncertainty

It is well documented that governments can exercise

an impact on the economy through legislation and