Political Party Affiliation of the President, Majority in Congress, and Sin Stock Returns

• Published date: 01 March 2017
• DOI: http://doi.org/10.1111/fima.12141
• Date: 01 March 2017
• Author: Mohammad Riaz Uddin,Salil K. Sarkar,Sanjiv Sabherwal

Political Party Affiliation

of the President, Majority in Congress,

and Sin Stock Returns

Sanjiv Sabherwal, Salil K. Sarkar, and Mohammad Riaz Uddin∗

Wefind that in contrast to the stock market, whichperforms better during Democratic presidencies,

“sin” stocks—publicly tradedproducers of tobacco, alcohol, and gaming—perform better during

Republican presidencies and even more so when the Republican presidency is accompanied by

a Republican majority in at least one chamber of Congress. We examine whether sin firms use

contributions to establish connections with politicians and find that sin firms contribute more to

Republican candidates and that these contributions are greater when Republicans are in power.

Wealso f ind a positive relationbetween political contributions and future returns. The relation is

stronger for contributions to Republicans.

Early academic research on the link between US politics and the equity market suggests there

is no significant difference in equity market performance between Democratic and Republican

presidencies (see, e.g., Niederhoffer, Gibbs, and Bullock, 1970). However, subsequent studies

present conflicting and interesting findings, resulting in increased attention of academics and

practitioners to the “presidential puzzle” of the relation between political cycle and the stock

market. Riley and Luksetich (1980) examine 20 presidential elections from 1900 to 1976 and

find that the stock market has a short-run positive reaction following the election of Republican

presidents and a negative reaction following the election of Democratic presidents. In contrast,

Santa-Clara and Valkanov (2003) examine stock returns from 1927 to 1998 and find that excess

returns are higher under Democratic presidencies.

Other notable studies on the presidential puzzle are Hensel and Ziemba (1995), Swensen

and Patel (2004), and Sy and Zaman (2011). Using data from 1928 to 1993, Hensel and

Ziemba (1995) find significantly higher returns for small-cap stocks during Democratic ad-

ministrations as compared to Republican administrations but identical returns for large-cap

stocks. In addition, they find significantly higher returns during Republican administrations

for corporate bonds, long-term and intermediate government bonds, and cash. Swensen and

Patel (2004) examine the New York Stock Exchange (NYSE) Composite Index from 1969 to

2000 and find that the possibility of positive returns, although not statistically significant, is

greater during Democratic presidencies. Sy and Zaman (2011) study 1926–2007 and find higher

We thank Michael Cooper, Huseyin Gulen, and Alexei Ovtchinnikov for generously providing the corporate political

contributions data used in their study “Corporate Political Contributions and Stock Returns,” Journal of Finance

(2010). Wealso thank Michael Cooper, Marc Lipson (Editor), David Rakowski,Rajiv Sabherwal, Trang Thai, John Wald,

and seminar participants at the 2012 Financial Management Association Conference, the 2011 Southwestern Finance

Association Conference, and the University of Texas at Arlington for their valuable suggestionsand comments.

∗Sanjiv Sabherwal is a Professorin the Department of Finance and Real Estate at the University of Texas at Arlington in

Arlington TX. Salil K. Sarkaris an Associate Professor in the Department of Finance and Real Estate at the University of

Texas at Arlingtonin Arlington TX. Mohammad Riaz Uddin is an Associate Professor in the Department of Accounting

& Finance at North South University in Dhaka, Bangladesh.

Financial Management •Spring 2017 •pages 3 – 31

4Financial Management rSpring 2017

returns during Democratic presidencies. They argue that the return differential can be attributed

mostly to Democratic presidencies being associated with higher risk premiums than Republican

presidencies.

Although the current literature generally seems to agree that returns for the overall stock

market are higher during Democratic versus Republican presidencies, we propose that the pattern

is likely to be the opposite for business sectors that are favored by Republicans. It is widely

believed that some industry sectors are strongly committed to one party or the other. Gimpel,

Lee, and Parrott (2014) analyze industry sector contributions to US congressional campaigns and

find wide variations in how economic sectors relate to the parties.1Therefore, it is reasonable to

suggest that the effects of the party affiliation of the president and the majority in Congress are

likely to vary across industry sectors.

In this study, wefocus on a specific sector that is believed to be more favored by Republicans.

This sector is “sin” or vice, that is, firms in the business of tobacco, alcohol, and gaming. With

increased awareness of sociallyresponsible investing, sin stocks lately are drawing more attention

from both practitioners and academics. Sin stocks are not investable by several norm-constrained

institutional investors such as pension funds and university endowments. Consequently, they are

neglected by several institutional investors and receive less analyst coverage. The products of sin

firms are associated with higher litigation risk, and social norms further enhance this risk (Hong

and Kacperczyk, 2009). Sin firms also face more scrutiny from regulators and the threat of new

regulations that may restrain their business. Fabozzi, Ma, and Oliphant (2008) discuss that there

are strict rules, regulations, and multijurisdictional laws that restrict the existence and actions of

firms in the sin industry. They also discuss that these firms face enhanced political risk and are

vulnerable to shifts in political positions.

The litigation risk and threat of enacting new regulations in restraining the sin sector are

higher in Democratic regimes than in Republican regimes. One reason for this difference is

that Republicans are generally more probusiness than Democrats. Blomberg and Hess (2003)

discuss the ideological differences between Democratic and Republican presidents. Democratic

administrations wish to increase government services whereas the Republican administrations

wish to reserve more resources for the private sector. It is well known that corporate groups are

interested in electing Republicans whereas labor groups and trial lawyersare interested in electing

Democrats. Brunell (2005) reports that corporate political action committees (PACs) givenearly

10 times as many donations to Republicans as to Democrats, whereas labor PACs givearound 20

times as many donations to Democrats as to Republicans.

It is well recognizedamong political scientists and economists that because f irms are affected by

government policy, they often use contributions to establish connections with politicians (see, e.g.,

Grier and Munger, 1991; Cooper, Gulen, and Ovtchinnikov, 2010). Studies such as Cooper et al.

(2010) also show that political connections established through contributions are economically

valuable to firms. The sin industry has become a major source of campaign contributions to

legislative candidates. Based on the data available from the Center for Responsive Politics for

1998-2014, the tobacco industry has donated more to the Republican Party than to the Democratic

Party in every two-year election cycle. Alcohol, gaming, and defense industries have exhibited a

similar pattern in a majority of the cycles. Monardi and Glantz (2003) examine tobacco industry

contributions during 1983–1996 and find that the tobacco industry has become a major contributor

1For example, natural resources extraction and rawmaterials manufacturing clearly tilt toward Republicans. In contrast,

water distribution systems and alternative energy production sectors favor Democrats. Retailing and most professional

and scientific services are nonpartisan.