Political uncertainty and investments by private and state‐owned enterprises

• Published date: 01 September 2023
• Author: Neeru Chaudhry,Chris Veld
• Date: 01 September 2023
• DOI: http://doi.org/10.1111/irfi.12410

ORIGINAL ARTICLE

Political uncertainty and investments by private

and state-owned enterprises

Neeru Chaudhry

1

| Chris Veld

2

1

Department of Management Studies, Indian

Institute of Technology Delhi, New Delhi,

India

2

Department of Banking and Finance of

Monash Business School, Monash University,

Melbourne, Victoria, Australia

Correspondence

Neeru Chaudhry, Department of Management

Studies, Indian Institute of Technology Delhi,

New Delhi 110 016, India.

Email: neeru.chaudhry@dms.iitd.ac.in

Abstract

We study corporate investments around national elections

in India. Investment rates drop by a nonsignificant 2.2% for

state-owned enterprises (SOEs) in election years. The

decrease is significantly larger for private firms, which

record an investment drop of 7.4%. The decrease in invest-

ment for private firms is likely attributable to political uncer-

tainty. SOEs balance political uncertainty with the desire to

woo voters who want government investments. Invest-

ments in election years are perceived positively for both pri-

vate firms and for SOEs. Increased investment by SOEs and

reduction in investment by private firms during election

years are associated with improved investment efficiency.

KEYWORDS

capital expenditure, election, investment, political uncertainty,

state-owned enterprises

JEL CLASSIFICATION

G31, G38

1|INTRODUCTION

Election outcomes affect corporate investments. This is because elections determine political leadership, which is in

turn responsible for formulating policies and regulatory frameworks for business operations. Such policies can

encourage or discourage investments by the corporate sector. For example, the surprise presidential election victory

of Donald Trump in 2016 led to a large shift in expectations, in the sense that corporate taxes would be lower and

trade policies more restrictive (Wagner et al., 2018). Both preceding and following the 2020 presidential elections in

the United States, there was a great deal of speculation on which sectors of the economy would see an increase in

opportunities after a Biden win, and which sectors would show poorer opportunities.

1

Received: 4 July 2021 Revised: 16 January 2023 Accepted: 26 January 2023

DOI: 10.1111/irfi.12410

© 2023 International Review of Finance Ltd.

584 International Review of Finance. 2023;23:584–614.

wileyonlinelibrary.com/journal/irfi

The effect of politics on corporate behavior, particularly on corporate investments, is not something restricted

to the United States. Julio and Yook (2012) study how corporate investment is related to the timing of national elec-

tions around the world. They find that firms reduce investment expenditures by an average of 4.8% in election years

compared to nonelection years. This drop in investments is attributed to the political uncertainty hypothesis,

according to which firms reduce investment expenditures until the electoral uncertainty is resolved. Alok and

Ayyagari (2020) investigate investments of state-owned enterprises (SOEs) in India and find that these firms increase

announcements of capital expenditure projects in election years. The reason for this increase is to woo voters who

wish to see investments in, for example, infrastructure.

Based on these seemingly different results, India's case warrants deeper investigation. In this paper, we look at

actual investments by publicly listed Indian companies. We compare SOEs to private sector firms (henceforth private

firms). We follow the definition of the Prowess database and define SOEs as firms for which the government,

national or state, is the majority shareholder and owns at least 51% of the equity in a firm. We study how the invest-

ment decisions between these two groups differ between election and nonelection years.

There is a potential endogeneity between political uncertainty and economic growth (which affects the aggre-

gate investment level), as the economic growth may induce political uncertainty. For instance, the recent economic

crisis in Sri Lanka led to unrest, causing removal of the prime minister of the country and thus heightening political

uncertainty.

2

In our case, such endogeneity may not be a concern. Timing of national elections in India represents a

source of exogenous variation in political uncertainty. National elections are held every 5 years and are conducted

by a constitutional body that is completely independent from the government as well as companies' influence. Dur-

ing our sample period, the national elections were held in 1996, 1998, 1999, 2004, 2009, 2014, and 2019. Except

for 1998 and 1999, all the elections were held following a gap of 5 years. In both these cases, the coalition govern-

ment failed, which led to early elections. These elections were not influenced by economic performance; rather, they

were mandated because the coalition government fell and they were beyond the control of the ruling party. The

fixed timing of national elections during our sample period alleviates concerns that they are endogenously deter-

mined by economic performance or are influenced by the ruling party.

All investment projects involve uncertainty and risk associated with future cash flows. The net present value

(NPV) rule accounts for the risks associated with future cash flows through the discount rate and suggeststhat firms

should invest in all projects with a positive NPV. However, an increase in uncertainty surrounding national elections

can cause managers to choose low levels of investment expenditure during election years and wait for the electoral

uncertainty to be resolved. This approach, which views investment opportunities as a call option, emphasizes the role

of risk and opportunity cost in addition to the discount rate and future cash flows. Even positive changes in policy

can represent an incentive for firms to delay investment, since the future outcome will have implications for the allo-

cation of firms' spending across various investment opportunities. The situation is more complicated for SOEs. The

managers of these companies must balance the interests of their private shareholders and those of the government.

They can be under pressure to increase investments in election years rather than to decrease them. Such an increase

can benefit the ruling government's vote, especially in areas with close elections, high-ranking politicians, and left-

wing incumbents (Alok & Ayyagari, 2020).

The Indian economy generally slows down before the national elections, a trend which has been observed over

the past 3–4 decades.

3

The anecdotal evidence suggests that political uncertainty is affecting private firms' proclivity

to invest in capital expenditures during election years.

4

For instance, in the financial year starting April 1, 2018 to

March 31, 2019, the combined value of new projects announced by government and private sector dropped by 19%

compared to those announced in the previous year (Vyas, 2019). This anecdotal evidence suggests that the drop in

investments during election years is in response to political uncertainty induced by elections.

India has a parliamentary system of government in which the executive power is vested in a cabinet responsible

to Parliament. The outcome of national elections determines the appointment of the prime minister, who is the head

of the cabinet and usually the leader of Parliament. Elections are organized by the Election Commission of India (ECI)

and are constitutionally mandated to be held once every 5 years. The government does not play any role in the

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