Essays on Political Economy and Finance

The thesis aims to explore the impact of political institutions on financial and investment policies. It contains three essays examining various aspects of political economy and its intersection with finance. In the first essay, we study how local political corruption and political uncertainty interact in their impact on corporate cash holdings within the United States. We find robust evidence that firms located in states with higher corruption scores react to increases in local political uncertainty by increasing cash holdings more than those in less corrupt settings. This behavior suggests that firms in more corrupt settings find it expedient to raise cash to facilitate the influence of officials in the face of local political risk. Our findings point to a potential channel through which different jurisdictions experience the entrenchment and persistence of corruption.

Following on from the evidence of political influence in the first essay, in the second essay, we explore a potential channel through which corruption could activate. In particular, the second essay finds that politically connected firms in the United States increase cash holdings and cash savings more than non-connected firms when faced with rising political uncertainty. We argue that connected firms respond in this manner to influence policymakers so as to navigate the uncertainty that could emerge from new policies and to adjust policies in the interest of the firm. To validate this argument we show that the amount of cash savings by connected firms located in more corrupt states when faced with uncertainty is positively associated with firms' political spending on campaign contributions and lobbying expenses.

In the third essay, we investigate the influence of generalized trust on labor regulation. Our findings show that OECD countries with a high level of trust chose to implement less stringent labor dismissal laws, suggesting that trust acts as a substitute for labor laws. We find that in a within-country analysis, trust acts as a substitute for labor laws in countries that are exposed to a low level of corruption whilst trust acts as a complementary for labor laws in countries that are exposed to a greater level of corruption. Furthermore, we validate the substitution effect by showing that trust positively relates to higher foreign direct investment flows. Our findings imply that having strong political institutions that protect the workforce through informal institutions could improve economic outcomes.