Red versus Blue in the Stock Market: Stock Return Comovement and Earnings Information Transfers

Abstract

Political polarisation has intensified significantly in recent decades in the United States (Gentzkow, 2016; Iyengar & Krupenkin, 2018). Individuals' political orientations increasingly influence their preferences and decisions. These influences spill over to the corporate sectors, affecting managers' policy choices and investors' investment choices (e.g. Hong & Kostovetsky, 2012; Hutton et al., 2014, 2015; Wintoki & Xi, 2020). This thesis comprises two studies examining the divisive effects of political polarisation on the US stock market. Specifically, it examines whether similarity in firm managers' political orientation is associated with the comovement of their firms' stock returns and earnings information transfers between them. Study 1 shows that the excess stock return comovement of firm pairs is positively associated with the political orientation similarity of their managers. This partisan-based return comovement is more pronounced in pairs with higher common institutional ownership, when both firms are politically aligned with the US president, and in pairs with higher common analyst coverage. In addition, investor attention also comoves more among politically similar firms. These results suggest that partisan return comovement can be attributed to style-based and habitat-based investing, as well as exposure to common information sources. Notably, partisan return comovement has increased rapidly in recent years, coinciding with heightened ideological division and affective hostility between Republicans and Democrats. Overall, the results indicate that the polarisation in US politics spills over into the stock market, which is becoming increasingly divided along party lines. Study 2 examines whether the extent of intra-industry information transfers during earnings announcements is influenced by the similarity in political orientations among corporate managers of announcing and non-announcing firms. I find that firm pairs with more similar political orientations experience stronger information transfers. Importantly, the partisan-driven information transfers during the earnings announcement period partially reverse subsequently, indicating biased market reactions based on political orientations. This effect concentrates on good news announcements and is more pronounced during periods of heightened policy uncertainty and in politically sensitive industries. Further analysis indicates that this effect is likely driven by differential investor trust in and differential investor interpretation of earnings information from politically aligned versus misaligned firms. Collectively, my findings provide evidence that partisan division hinders efficient information flows in the stock market, because political alignment affects how partisan investors incorporate information disclosed by managers of industry peer firms with strong political orientations. Show more