Brandon Julio

Policy Uncertainty, Irreversibility, and Cross-Border Flows of Capital

We examine the effects of political uncertainty on cross-border capital flows using election timing as a source of fluctuations in political uncertainty. FDI flows from US companies to foreign affiliates drop significantly during the period just before an election and increase after the uncertainty is resolved, consistent with the view that political uncertainty deters foreign investment. The electoral patterns in FDI flows are more pronounced when elections are more competitive. The impact of political uncertainty on FDI flows depends on the level of institutional quality. Countries with higher levels of institutional quality experience significantly less variation in FDI around election cycles.

The Bright Side of Political Uncertainty: The Case of R&D

We examine the relationship between political uncertainty and R&D investment by exploiting the timing of U.S. gubernatorial elections as a source of plausibly exogenous variation in uncertainty. In contrast to the literature documenting negative effects of political uncertainty on real investment, we find that uncertainty over government policy encourages firm-level R&D. Firms increase R&D investments by an average of 4.6% in election years relative to non-election years. The uncertainty effect is stronger in hotly contested elections, in politically sensitive and hard-to-innovate industries, and in firms subject to higher growth options and greater product market competition. Our findings suggest that, as predicted by models of investment under uncertainty, the real effects of political uncertainty depend on the properties of the investment and the degree of product market competition and therefore the total effect of political uncertainty on the long-run growth of an economy is unclear.

Political Turnover, Ownership, and Corporate Investment

We examine the impact of political influence and ownership on corporate investment by exploiting the unique way provincial leaders are selected and promoted in China. The tournament-style promotion system creates incentives for new provincial governors to exert their influence over capital allocation, particularly during the early years of their term. Using a neighboring-province difference-in-differences estimation approach, we find that there is a divergence in investment rates between state owned enterprises (SOEs) and non-state owned enterprises (non-SOEs) following political turnover. SOEs experience an abnormal increase in investment by 6.0% in the year following the turnover, consistent with the incentives of a new governor to stimulate investment. In contrast, investment rates for non-SOEs decline significantly post-turnover, suggesting that the political influence exerted over SOEs crowds out private investment. The effects of political turnover on investment are mainly driven by normal turnovers, and turnovers with less-educated or local-born successors. Finally, we provide evidence that the political incentives around the turnover of provincial governors represent a misallocation of capital as measures of investment efficiency decline post-turnover.

Earnings Management and Corporate Investment Decisions

We investigate the relationship between earnings management and the efficiency of corporate investment decisions. Using discretionary accruals to measure intertemporal transfers of earnings, we show that earnings management exhibits a concave relationship with the investment sensitivity to investment opportunities as measured by Tobins Q. We find that the association is concentrated among high Q firms. The effect is present among well governed firms, suggesting that better governed firms manage accruals strategically. The concave relationship suggests that the marginal impact of earnings management on investment efficiency decreases with the amount of earnings management. Using cases of misreporting, we document that excessive earnings management does not improve investment efficiency. Taken together, these results support the view that a moderate amount of earnings management helps improve corporate investment decisions while an excessive amount undoes the benefit of earnings management.

A Bit Goes a Long Way: Bilateral Investment Treaties and Cross-Border Mergers

We examine whether Bilateral Investment Treaties (BITs) remove impediments to foreign investment by helping enforce contracts and property rights. We find that BITs have a large, positive effect on cross-border mergers: the probability and dollar volume of mergers between two given countries more than doubles after the signing of a BIT. Most of this increase is driven by capital flowing from developed economies to developing economies, answering the long-standing Lucas Paradox as to why most cross-border capital still flows to developed countries. Additionally, most of our results are driven by target countries with “medium” levels of political risk, consistent with popular views that BITs are ineffective for countries with very high risk and not necessary for countries with low political risk.

Corporate Investment and the Option to Repurchase Debt

The presence of risky debt in a firm’s capital structure can le ad to inefficient investment decisions when managers act in the interest of shareholders. Based on this agency cost perspective, I describe the market for debt repurchases and examine whether debt repurchase activity is consistent with a firm’s desire to mitigate debt overhang. I pres ent an agency model of debt which demonstrates that when a firm faces a debt overhang problem, t he value of a reduction in debt can outweigh the cost of the repurchase and increase the welfare of both stockholders and bondholders. Using a sample of debt repurchases initiated by U.S. firms ove r the period 1996 to 2004, I find evidence consistent with the agency cost model of corporate debt policy. Specifically, I find that firms are more likely to repurchase outstanding debt either b y open market transactions or tender offers when potential transfers to bondholders are high. Employing a matching methodology based on propensity scores, I document significant increases in fir m investment levels and efficiency for repurchasing firms relative to a control sample. This improv ement is more pronounced for firms with higher expected transfers to bondholders (overhang). In addition, the efficiency improvements are concentrated in investment expenditures related to new investment projects, rather than in expenditures on maintaining existing assets. This finding is r obust to corrections for selection bias and endogeneity, as well as various proxies for growth opportunities.

Executive Summary: Strategic Hesitance

Brandon Julio and Youngsuk Yook, ‘Political uncertainty and corporate investment cycles’, The Journal of Finance 67, no. 1, 2012.