Mitigating policy uncertainty: What financial markets reveal about firm‐level lobbying

Abstract Elections can lead to substantial policy changes and, thus, are a significant source of risk. Firms can respond to such policy uncertainty by lobbying, but it is hard to quantify whether they do so and, if so, how much lobbying benefits them. We construct a new dataset and leverage investors’ expectations of variability in stock returns in the aftermath of the 2020 US presidential election to generate a new firm‐level measure of exposure to policy uncertainty. We show that lobbying reduces policy uncertainty, and that this result holds even after controlling for selection into lobbying and sectoral heterogeneity. We then develop and quantify a model of heterogeneous firms with endogenous lobbying. We find that affecting policy through lobbying is costly and the returns from it are highly skewed and rapidly diminishing. Thus, while lobbying expenditures reduce the impact of policy risk, few firms anticipate sufficient gains to invest in it.