Pushing the future back: The impact of policy uncertainty on the market pricing of future earnings

Abstract

We examine whether policy uncertainty triggered by presidential elections pushes the future back by reducing the extent to which current prices reflect information about future earnings. We estimate future earnings response coefficients (FERCs) for the years 1975–2013, a period that covers ten presidential elections. We find that FERCs are significantly lower (by 11.8%) during presidential election years compared to other years. Additional analyses using pseudo election years, ex‐ante polls, contract prices from the Iowa Electronic Political Market, and cross‐sectional firm characteristics provide corroborating evidence that the lower FERCs during election years are related to policy uncertainty. We also investigate potential explanations for the lower FERCs during election years. We find that the lower FERCs relate to forecasting difficulty rather than to changes in the discount rate or in the amount of noise trading. Finally, we find that market prices move toward future earnings to a greater degree during presidential election years compared with other years once the policy uncertainty is resolved. A trading strategy based on this drift yields significant abnormal returns. Overall, we contribute to the literature by providing the first empirical evidence that shocks to policy uncertainty influence the pricing of earnings information.

Hedging on the Hill: Does Political Hedging Reduce Firm Risk?

“…One motivation for managers to alleviate firm risk is to help reduce investor uncertainty about corporate performance and thereby improve the information environment (Caskey 2009, Verrecchia 1983. Drake et al (2018) show that uncertainty about government policies makes it more difficult for market participants to incorporate information about future earnings into current stock prices. If political hedging helps alleviate some of this uncertainty for firms, it should be easier for investors to anticipate and process earnings signals of firms who engage in political hedging.…”

Does economic policy uncertainty matter for financial reporting quality? Evidence from the United States

“…The extant literature identifies two general types of uncertainty-political uncertainty and economic uncertainty (Bloom 2014). Political uncertainty is the lack of certainty in politics (Drake et al 2018;Kang and Wang 2018). Economic uncertainty refers to the uncertainty that stems from the general economic conditions and the business cycle (Bloom 2009;Baker and Bloom 2013).…”

Does Economic Policy Uncertainty Matter for Financial Reporting Quality? Evidence from the United States

“…The extant literature identifies two general types of uncertaintypolitical uncertainty and economic uncertainty (Bloom 2014). Political uncertainty is the lack of certainty in politics (Drake et al 2018;Kang and Wang 2018). Economic uncertainty refers to the uncertainty that stems from the general economic conditions and the business cycle (Bloom 2009;Baker and Bloom 2013).…”