Political Uncertainty and Cost Stickiness: Evidence from Prefecture-city Official Turnover in China

How politics influences firm behaviours and economic outcomes is a longstanding question in research and public debate. One important way in which politics is conjectured to influence real decisions is through the channel of uncertainty. While extensive prior studies focus on the impact of political uncertainty on firms’ investment and financing activities, the evidence on how political uncertainty affects firms’ operating decisions remains scarce. To fill this gap in the literature, this study investigates the impact of political uncertainty on asymmetric cost behaviour (i.e. cost stickiness) for listed firms in China. Using the turnover of prefecture-city officials as a measure of exogenous fluctuations in political uncertainty, we find that political turnover leads to a higher degree of cost stickiness, implying that firms retain slack resources when political uncertainty is high. Moreover, the effect of political uncertainty on cost stickiness is more pronounced for firms residing in regions with weak institutional environment, firms that are privately owned and with small size, and when the newly appointed official is from a different city. Our findings suggest that political uncertainty is an important channel through which the local political process influences corporate operational decisions, thus firms should take political uncertainty into account when setting their resource adjustment policies.