WORKING PAPER Does Political Partisanship Cross Borders

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Does Political Partisanship Cross Borders? Evidence from International Capital Flows
Elisabeth Kempf, Mancy Luo, Larissa Schäfer, and Margarita Tsoutsoura
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Does Political Partisanship Cross Borders? Evidence from International Capital Flows ∗
Elisabeth Kempf, Chicago Booth, CEPR, and NBER Mancy Luo, Erasmus University
Larissa Scha¨fer, Frankfurt School of Finance & Management and CEPR Margarita Tsoutsoura, Cornell University, CEPR, ECGI, and NBER
February 1, 2022
Abstract Does partisan perception shape the flow of international capital? We provide evidence from two settings, syndicated corporate loans and equity mutual funds, to show ideological alignment with foreign governments affects the cross-border capital allocation by U.S. institutional investors. Our empirical strategy ensures direct economic effects of foreign elections or government ties between countries are not driving the result. Ideological alignment with foreign countries may also affect capital allocation of non-U.S. investors and can explain patterns in bilateral investment. Combined, our findings imply partisan perception is a global phenomenon and its economic effects transcend national borders.
∗We are grateful for comments from Tobias Berg, Filippo De Marco (discussant), Mariassunta Giannetti (discussant), Laurence van Lent, Raghuram Rajan, Antoinette Schoar, Roger Silvers, Noah Stoffman (discussant), Simon Strautmann (discussant), Felix von Meyerinck, and seminar/conference participants at Bank of Portugal, Boston College, Central Bank of Ireland, DGF 2021, Durham University, Emory University, ESCP Business School Berlin, Frankfurt School of Finance & Management, Goethe (SAFE) University, Indiana University, JEF Seminar, LUISS University, POLFIN Workshop London, Texas Finance Festival, University of Bristol, University of Southampton, and University of Tu¨bingen. Kempf gratefully acknowledges financial support from the Initiative on Global Markets and the Fama-Miller Center for Research in Finance at Chicago Booth. We thank Xinyu Cao, Emirhan Ilhan, Zichen Zhao and, especially, Laurenz De Rosa for excellent research assistance.

1 Introduction
A significant body of work in political science and economics has documented a rising partisan divide in the U.S. (e.g., Iyengar, Sood, and Lelkes (2012); Mason (2013); Mason (2015); Gentzkow (2016); Boxell, Gentzkow, and Shapiro (2017); Fos, Kempf, and Tsoutsoura (2021)).1 In particular, voters have an increased tendency to view the 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.2 Recent work shows this partisan perception influences not only the economic decisions of households, but also those of more sophisticated individuals and in high-stakes environments, such as credit analysts (Kempf and Tsoutsoura (2021)), loan officers (Dagostino, Gao, and Ma (2020)), executives (Rice (2020)), entrepreneurs (Engelberg, Guzman, Lu, and Mullins (2021)), and mutual fund managers (Cassidy and Vorsatz (2021)).3 However, we 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. We fill this gap by exploring whether cross-border investments by large institutional investors are shaped by their ideological alignment with elected foreign parties.
This consideration is important for several reasons. First, it is not obvious that investors are as polarized over foreign politics as they are over domestic issues. In the U.S., a long-standing belief is that partisan disputes should be internal matters and stop at
1Trends in polarization vary across countries and are strongest in the U.S., as shown by Boxell, Gentzkow, and Shapiro (2020).
2See, for example, Bartels (2002), Gaines, Kuklinski, Quirk, Peyton, and Verkuilen (2007), Gerber and Huber (2009), Curtin (2016), Mian, Sufi, and Khoshkhou (2017), Coibion, Gorodnichenko, and Weber (2020)).
3For households, political alignment with the government has been documented to affect decisions related to housing (McCartney and Zhang (2019)) and portfolio allocation (Addoum and Kumar (2016); Bonaparte, Kumar, and Page (2017); Meeuwis, Parker, Schoar, and Simester (2018)), as well as risk perception (Barrios and Hochberg (2020)). The evidence on consumption is mixed (e.g., Gerber and Huber (2009); Gillitzer and Prasad (2018); Mian, Sufi, and Khoshkhou (2017)).

the nation’s border.4 Second, cross-border capital flows have become an important factor of international firm investment and growth (Brunnermeier, De Gregorio, Eichengreen, El-Erian, and Fraga (2012)). If partisan perception affects not only domestic capital allocation but also cross-border capital flows, the economic effects of partisan perception are much broader than previously thought. Third, the extent to which the domestic partisan alignment effect reflects partisan animosity (i.e., pessimism induced by the other “team” being in power) or partisan disagreement about the effectiveness of different government policies (irrespective of which team implements them) has remained an open question. If partisan alignment matters in international contexts as well, this finding points toward disagreement about policies being the main driver of the effect, unless partisan investors adopt a very broad definition of who is on their team. Hence, studying international capital allocation also allows us to make progress on understanding the potential mechanisms behind the partisan-perception phenomenon.
In this paper, we provide the first evidence that partisan perception of private investors also matters in international contexts. Using two independent settings, syndicated corporate loans and equity mutual funds, we show investors invest less in another country when they are ideologically more distant from that country’s party in power. The two settings provide an ideal laboratory for our tests, because they speak to an important part of cross-border capital flows. They further allow us to observe private capital flows at the level of an individual investor, that is, a bank or a mutual fund, whom we can then link to political affiliations, using political contributions or voter registration records.5
Isolating the effect of ideological alignment with foreign governments on capital-allocation decisions is empirically challenging for two main reasons. First, the ideological alignment
4For example, U.S. Senator Vandenberg famously stated during the cold war that “we must stop partisan politics at the water’s edge.” Despite this long held view, Jeong and Quirk (2019) find evidence of foreign policy polarization between Democrats and Republicans in the Senate.
5Syndicated loans represent around three-quarters of total cross-border lending to non-financial corporations (Gadanecz and von Kleist (2002); Chodorow-Reich (2014); Cerutti, Hale, and Minoiu (2015); Doerr and Schaz (2021)). According to the 2021 Fact Book of Investment Company Institute (ICI), as of 2020, the U.S. open-ended mutual fund industry managed about $29 trillion assets, of which approximately 15% were invested abroad (Hau and Rey (2008)).

between an investor and a destination country could correlate with other measures of proximity, such as cultural, lingual, or religious commonalities (e.g., Fisman, Paravisini, and Vig (2017)). Second, expected investment returns in the destination country may be directly affected by changes in government policies or political uncertainty (e.g., Pastor and Veronesi (2012)). To address these challenges, our empirical strategy examines changes in the capital allocation by partisan investors from the same home country investing in the same destination country around the same foreign national election. The following thought experiment illustrates our empirical approach. Assume two U.S. banks, one Republican and one Democratic, that extend loans to Canadian firms. After the Canadian federal election in 2015, the incumbent Conservative Party of Stephen Harper (right) was succeeded by the Liberal Party led by Justin Trudeau (left). As a result of the election, the Republican bank’s ideological distance from the party in power increases relative to that of the Democratic bank. We can then compare the change in lending to Canadian firms by the two banks before and after the election, using a difference-in-differences design.
Our main analysis focuses on U.S. investors, due to the better availability of measures of political affiliations and because the U.S. has experienced the greatest increase in polarization over recent decades (Boxell, Gentzkow, and Shapiro (2020)). The first setting we analyze covers cross-border syndicated corporate loans. An important advantage of the corporate loan setting is that prior literature has established a direct link between the supply of syndicated loans and the real economy (e.g., Chodorow-Reich (2014); Acharya, Eisert, Eufinger, and Hirsch (2018)). We use banks’ political contributions to infer their ideological leaning and compute their ideological distance to elected foreign parties, using the left-right ideology score from the Manifesto Project Database (Volkens, Lehmann, Matthieß, Merz, Regel, and Weßels (2018)). We find that, when a bank experiences an increase in ideological distance after a foreign election, it reduces its lending volume by 22% and the number of loans by 10%, relative to banks experiencing a decrease in distance. The magnitude of this effect is comparable to the flight-home effect documented in Giannetti

and Laeven (2012). We further document a decrease in the loan quantity provided by misaligned banks even within the same loan. This result is important because it allows us to rule out that the relative decline in loan quantity is driven by differences in borrower demand. In terms of loan pricing, we find a sizable, positive effect of ideological distance on loan spreads. An increase in ideological distance is associated with a 13.9% increase in loan spreads, which translates to approximately 30 basis points for the average loan in our sample. We further show that the effect on loan spreads is stronger for relationship banks, which have greater market power vis-`a-vis their clients. Finally, we document that loans issued by misaligned and aligned banks do not exhibit different ex-post default rates. The absence of ex-post differences in defaults further supports our interpretation that we are capturing differences in the economic perceptions of Republican and Democratic banks, rather than differences in the riskiness of their borrowers.
The second setting we study is international equity mutual funds. The mutual fund setting is convenient in that it allows us to identify individual decision makers (i.e., fund managers) and link them to party affiliations from U.S. voter registration records, which represent a cleaner measure of political ideology than political contributions (Fos, Kempf, and Tsoutsoura (2021)). We find that, when the ideological distance between a fund’s management team and a foreign country increases following an election, the fund reduces the share of its portfolio allocated to this country by 26 basis points, relative to a fund that experiences a decrease in 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 crosspartisan heterogeneity in investors’ beliefs about aggregate economic conditions in the destination country (see Kempf and Tsoutsoura (2021) and Meeuwis, Parker, Schoar, and Simester (2018)). To further strengthen 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, relative to banks with a decrease in distance. In addition to supporting the mechanism, the GDP forecast result is interesting in its own right. To the best of our knowledge, it represents the first evidence of partisanship affecting professional forecasts around political elections.
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. First, we examine aggregate syndicated loan issuance by U.S. banks at the industry level. We find that in industries with a larger fraction of ideologically misaligned banks, a larger reduction in loan-issuance volume occurs around the election. This result is consistent with ideologically aligned banks not being able to increase their loan supply sufficiently to compensate for the reduction in capital supply by misaligned banks. Next, we show 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% lower portfolio positions and 6.8% lower FDI flows. A caveat in this analysis is that we cannot exploit within-country variation as in our main tests. This increases the set of potential omitted variables and requires us to make stronger assumptions to interpret the evidence as causal.
Finally, we extend our analysis to non-U.S. investors. We infer the party affiliation of non-U.S. investors using novel, hand-collected data on political contributions from Canada and the United Kingdom (U.K.). The resulting evidence is mixed. Non-U.S. banks experience no significant effect of ideological alignment, consistent with political polarization being less pronounced outside the U.S. (Boxell, Gentzkow, and Shapiro (2020)). Neverthe-

less, for non-U.S. 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 U.K., 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.
2 Related Literature
Our study contributes to several strands of the literature. First, we contribute to the literature that studies how partisanship influences investors’ response to political events. For example, Bonaparte, Kumar, and Page (2017) find investors’ portfolio allocation to risky assets is influenced by whether their preferred party is in power. Meeuwis, Parker, Schoar, and Simester (2018) document that Republican investors actively increase the equity share and the market beta of their portfolios relative to Democrats following the U.S. election of November 2016. Moreover, Kempf and Tsoutsoura (2021), Dagostino, Gao, and Ma (2020), and Cassidy and Vorsatz (2021) show political alignment with the domestic party in power also affects the rating decisions by U.S. credit analysts, corporate loan spreads charged by U.S. loan officers, and investments by professional money managers. Related, Wintoki and Xi (2020) find fund managers are more likely to allocate assets to firms whose leadership shares their political affiliation, and Duchin, Farroukh, Harford, and Patel (2019) show firms are more likely to merge if their employees have similar political attitudes. Our

contribution, relative to these studies, is to document that partisan alignment is not a U.S.-specific phenomenon and matters in international contexts as well. Specifically, we show partisan perception influences cross-border investments by both U.S. and non-U.S. investors and can explain important patterns in cross-border flows of capital.
More broadly, we contribute to a growing literature that examines how financial markets respond to political events. One strand of this literature focuses on how political uncertainty surrounding political elections affects capital flows and securities prices. Boutchkova, Doshi, Durnev, and Molchanov (2012) find that industries sensitive to politics have more volatile returns around elections. Kelly, Pa´stor, and Veronesi (2016) document that political uncertainty is priced in financial options. Julio and Yook (2016) show FDI flows are lower around elections, due to policy uncertainty. Finally, Azzimonti (2019) finds a negative relationship between partisan conflict among U.S. lawmakers and private investment. In this study, we control for the channels of political uncertainty and partisan conflict among lawmakers by exploiting cross-sectional heterogeneity across investors around the same foreign election.
Our paper also adds to a strand of the literature that examines the determinants of cross-border investments. Our paper is most closely related to the literature that emphasizes the influence of cultural and social proximity on cross-border capital flows. Guiso, Sapienza, and Zingales (2009) find cultural distance between countries reduces foreign direct investment. For bank lending, cultural distance between banks and their borrowers has been shown to lead to reduced lending by multinational banks (Mian (2006)) and to higher interest rates (Giannetti and Yafeh (2012)). For cross-border portfolio investment, Hwang (2011) documents that higher levels of country popularity with Americans are associated with larger mutual fund inflows and larger foreign portfolio investments by U.S. retail investors. Moreover, Bhattacharya and Groznik (2008) show U.S. investments in a foreign country are positively affected by the size of the foreign-origin group from that country living in the U.S.. Finally, Bottazzi, Da Rin, and Hellmann (2016) document that

the Eurobarometer measure of trust among nations positively predicts investment decisions by venture capital firms, and Ahern, Daminelli, and Fracassi (2015) find the volume of cross-border mergers is lower when countries are culturally more distant. In addition to cultural proximity between countries, a few papers have studied the importance of bilateral political relationships. Closer bilateral political relations have been shown to be associated with increased cross-border portfolio and direct investment flows (Gupta and Yu (2007)), as well as with increased cross-border M&A activity (Kose, Lin, and Qi (2016)). Moreover, cross-border investments benefit from heightened cooperation between securities regulators (Silvers (2021)). In this paper, we focus on variation in ideological proximity across investors from the same home country investing in the same destination country at the same point in time, and on time-variation in this proximity brought about by political elections. We can therefore control for any time-invariant differences across investor-country pairs, including cultural, lingual, religious, and geographical proximity, as well as for time-varying bilateral relationships between countries.
Furthermore, we contribute to the literature that studies how political affiliation correlates with the behavior of financial analysts, corporate managers, professional investment managers, and retail investors. Prior studies document that mutual fund managers who make campaign donations to the Democratic Party hold less of their portfolios in companies that are deemed socially irresponsible (Hong and Kostovetsky (2012)), left-wing voters are less likely to invest in stocks (Kaustia and Torstila (2011)), sell-side equity analysts who make political contributions to the Republican Party are less likely to issue bold recommendations (Jiang, Kumar, and Law (2016)), Republican firm managers maintain more conservative corporate policies (Hutton, Jiang, and Kumar (2014)), and Republicanleaning lenders originate more climate-exposed loans (Zhang (2021)). These studies focus on the time-invariant attributes that characterize Democrats versus Republicans, whereas we focus on how the behavior of investors changes depending on their ideological proximity to the party in power. We can, therefore, separate the effect of partisan perception from

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WORKING PAPER Does Political Partisanship Cross Borders