Political sentiment and abnormal accruals

Abstract

Firms exhibiting high political sentiment can be desirable for investors as a hedging tool, which increases the demand for their stocks due to the mispricing related to manger’s sentiment and intertemporal hedging demand. A long-short portfolio of firms corresponding to the quintiles of political sentiment has a positive alpha spread. We document a positive relationship between political sentiment and abnormal accruals, which implies that corporate executives who engage in accruals-based earnings management also discuss political risk more frequently during earnings calls. Some managers tend to portray their firms as politically sensitive to mitigate the risks of high accruals. Indeed, our distance-to-default analyses suggest that political sentiment ameliorates the negative effects of high accruals. Double-sorted portfolios on political sentiment and abnormal accruals earn significant positive alphas in the month/quarter of earnings call.