A new empirical paper explores how partisan perception affects capital allocation beyond national borders, showing that the global investment practices of US institutional investors reflect the widening domestic partisan divide.
A significant body of work in political science and economics has documented a rising partisan divide in the US. In particular, voters have an increased tendency to view the domestic economy through a “partisan perceptual screen’’—that is, their views of economic conditions are influenced by whether the White House is occupied by the party they support. However, researchers have a limited understanding of the scope of the economic implications of the partisan-perception phenomenon. In particular, no evidence exists to date regarding whether partisan perception transcends national borders, which could lead to distortions in capital allocation on a much larger scale.
In our new BFI working paper, we show that global investment practices by US institutional investors have reflected the widening domestic partisan divide. Our main conjecture is that political alignment with foreign governments affects how optimistic investors are about the local economy. For example, a Republican-identified bank supplying corporate loans to a country with a more right-wing government might expect lower default levels than it would from a left-leaning administration; or money managers might expect higher returns from stocks in countries that align with their politics.
To test this hypothesis, we analyze the investment decisions of US banks and international mutual fund managers around foreign elections that induce changes in investors’ political alignment with the party in power. Data on cross-border syndicated corporate loans are obtained from the DealScan database, maintained by the Loan Pricing Corporation (LPC DealScan). Our sample covers 83 percent of the aggregate cross-border lending volume by US banks between 2000 and 2018. To identify the political leaning of banks, we use contributions from political action committees and individuals, as compiled by the nonprofit Center for Responsive Politics (now OpenSecrets). For US-based mutual funds with a mandate to invest internationally, we obtain semi-annual fund holdings information from the FactSet International Ownership database, spanning years 2000 to 2018. To measure the political ideology of the fund management team, we link individual fund managers to party affiliations in voter registration records that we obtained for nine US states. To measure the ideological distance between our sample of US investors and elected foreign parties, we draw on the Manifesto Project Dataset, which analyzes the manifestos of 1,000 political parties in more than 50 countries and allows us to score these parties on the left-right political spectrum.
For banks, we find that they extend fewer corporate loans in a foreign country when they are less politically aligned with the ruling party in that country. Specifically, when an election widens the political divide between a bank and a country, the bank reduces its lending volume to that country by an average of 22 percent and the number of loans by 10 percent, relative to banks that become more politically aligned with the country. The closer the election results and the more intensive the media coverage, the greater the effect, supporting the notion that the change in behavior is indeed induced by the election outcome. Importantly, we can rule out the possibility that the change in loan quantity is due to differences in borrowers’ demand for loans, since we observe differences in loan shares by aligned versus misaligned banks even within the same loan.
Additionally, we find that ideological differences between a bank and a foreign borrower lead to a 13.9 percent increase in loan spreads—equal to about 30 basis points for the average loan. This result is consistent with banks becoming more pessimistic about future default rates when their ideological distance to the foreign country increases. Meanwhile, there is no change in the ex-post default rates of firms that borrow from aligned versus misaligned banks, further strengthening the interpretation that the change in lending behavior is driven by banks’ perception of borrowers’ riskiness, rather than on their actual riskiness.
For mutual funds, we see that they reduce the share of their portfolios allocated to a country’s equity by 26 basis points following elections that widen their political distance. The granularity of the mutual fund holdings data further allows us to compare capital allocation within the same security, ensuring our results are not driven by differences in the types of securities held by Republican and Democrat fund managers.
We argue the mechanism behind the observed differences in capital allocation is cross-partisan heterogeneity in investors’ beliefs about aggregate economic conditions in the destination country. That is, investors who are politically aligned with a foreign government are more optimistic about economic conditions in that country than politically misaligned investors. To provide direct support for this interpretation, we study changes in banks’ GDP growth forecasts around foreign elections. We find banks that experience an increase in ideological distance are more likely to revise their one-year-ahead GDP growth forecasts downward, consistent with these banks becoming more pessimistic about the local economy relative to other banks.
Our main tests establish relative differences in capital supply between investors who experience an increase versus decrease in ideological distance. Does partisan perception also affect the net supply of capital? To explore this question, we study how ideological distance is associated with capital flows at a more aggregate level. We find that ideological distance between two countries is negatively correlated with bilateral portfolio positions and bilateral foreign direct investment (FDI) flows. A one-standard-deviation greater ideological distance between the governing party in two countries is associated with 3.7 percent lower portfolio positions and 6.8 percent lower FDI flows.
Finally, we extend our analysis to non-US investors. We infer the party affiliation of non-US investors using hand-collected data on political contributions from Canada and the United Kingdom (UK). The resulting evidence is mixed. Non-US banks experience no significant effect of ideological alignment, consistent with political polarization being less pronounced outside the US. Nevertheless, for non-US fund managers, we do find an economically and statistically significant effect. This finding might be due to higher reporting thresholds for political contributions in the UK, which may lead us to capture more partisan individuals. Understanding the sources of cross-country variation in the economic influence of political partisanship is a fruitful avenue for future research in our view.
Taken together, our results portray a compelling picture of partisan perception transcending national borders and shaping cross-border investments. The economic effects of partisan perception are thus much broader than previously thought. Our results also imply ideological alignment is an important, omitted factor in models of international capital flows and provide a new perspective on the macroeconomic risk of political election outcomes. In particular, our results suggest that even elections of fairly moderate political parties can trigger large changes in capital flows, depending on the ideology of the investor.
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