The Effects of Political Risk on Corporate Compliance Violations

Abstract We investigate the influence of firm‐specific political risk on corporate compliance violations and associated costs. Using a novel measure of political risk derived from earnings call transcripts, we uncover a significant positive relationship between political risk exposure and the likelihood, frequency, and magnitude of compliance fines and settlements. This relationship remains robust across various violation cost measures and components of political risk. Moreover, our findings show that the impact of compliance violations on future realized cash flows is considerably more pronounced for firms with high levels of political risk compared to their low‐risk counterparts. Our results highlight the costly implications of political risk even in developed markets, reinforcing the importance of effective risk mitigation strategies for protecting shareholder value.