Seeing risk, seizing opportunity: How perceived political instability affects firm investment

Abstract

Does firm managers’ perception of political instability influence firms’ investment decisions? Using a large firm-level survey data of over 147,000 firms operating in 153 countries, we find evidence that a higher perception of political instability is positively related to firms’ investments. This effect is observed both on the extensive margin (likelihood to invest) and intensive margin (amount invested) and for investment in both land and equipment. Perception of political instability also influence how firms finance their investments: firms hold more cash on hand and borrow more from banks when they perceive political instability to be high. We also document that this effect is only observable for small and medium enterprises and those operating in less democratic regimes. The actual level of political instability in a country, however, has no effect on firm investment. Our results are robust to a battery of sensitivity tests.