Uncertainty, Precautionary Saving, and Investment: Evidence from Pre-scheduled Election Cycles

Author(s): 
Candace E. Jens, Whitman School, Syracuse University
T. Beau Page, Financial Economist, Office of the Comptroller of the Currency


Journal:
Financial Management (2024)

Summary:
Elections create uncertainty about future government policies, so, before elections, firms build up their cash balances to provide a buffer for the month of and months following elections.

Research Questions:
Do firms adjust their active cash management before, during, and after high-uncertainty periods surrounding gubernatorial elections?

Can any changes to firms’ cash management around elections be explained by contemporaneous changes to firm investment, or are changes to cash driven by changes to firms’ saving policies?

What We Know:
We know that firms time big investments around elections—there is a temporary dip in both capital expenditures and mergers and acquisition announcements around elections—but how firms manage cash around elections had not yet been studied.

Novel Findings:
We examine cash holdings and related financing activities around elections and show that firms display several behaviors consistent with precautionary saving before elections.  We compare the saving and financing activities of firms in election states to firms in non-election states, which allows us to examine whether firms adjust their saving policies around elections and how these effects vary across firms.  Large firms and firms with more reliable access to external capital markets do not greatly alter their cash on hand but adjust their debt raised and retired to lower their leverage ratios by approximately 2%.  Effectively, a slight reduction in leverage ratios means that these firms have built “wiggle room” into their leverage ratios to ensure funding should a cash shortfall occur.  The saving and financing behavior of small, rapidly growing firms is most susceptible to uncertainty from elections.  These firms tend to have neither saved cash nor reliable cash flows and need to continuously tap external markets for financing.  We show that these firms shift seasoned equity offerings backward in time and increase the size of seasoned equity offerings, resulting in a buildup of approximately one to two extra months of cash before elections.  Changes to firms’ savings and cash balances occur several quarters before any adjustments to firms’ investment activities.  Our use of elections as a source of uncertainty is key to this finding—because elections are predictable, firms can adjust their saving up to a year in advance, decoupling in time any changes in investment and saving policies.  Other sources of uncertainty are less predictable, so changes to firms’ saving and investment policies occur simultaneously when these measures of uncertainty are high.

Full Citation:
 Jens, Candace E. and T. Beau Page, 2024. Uncertainty, Precautionary Saving, and Investment: Evidence from Pre-scheduled Election Cycles. Financial Management, forthcoming.

Abstract:
We show empirically that firms increase cash holdings starting as early as one year before pre-scheduled (i.e., predictable) elections.  Then, for four quarters around elections when uncertainty and external financing costs are high, firms decrease investment and draw down saved cash balances to avoid tapping external financing. We use a dynamic model of firm investment and saving to demonstrate the importance of anticipation of future financing costs to firms’ pre-election precautionary saving behavior.  Theoretically, if election uncertainty were only to affect potential investment, lower firm investment would result in higher contemporaneous cash balances, which is inconsistent with our empirical results.