We examine how political geography affects firms' cost of debt. Local policy risk, measured by proximity to political power reflected in firms' position in the country's political map, is positively related to firms' cost of debt. Employing a difference-in-difference-in-differences (DDD) estimation around presidential elections, we find that firms headquartered in states that become more aligned with the president after elections are exposed to more policy risk and thus incur higher yield spreads. Firms can manage policy risk by engaging in corporate political strategies. Consistent with the view that such political strategies protect firms against uncertainty about future policies, we find policy risk has less of an impact on a firm's cost of debt when the firm makes more PAC contributions or spends more money on lobbying.

Using a sample of state pension funds’ equity holdings, we find evidence of not only local bias, but also bias towards politically-connected stocks. Political bias is detrimental to fund performance. State pension funds have longer holding durations of politically-connected local firms and display disposition behavior in these positions. Political bias is positively related to the percentage of politically-affiliated trustees on the board and Congressional connections. The more politically-affiliated trustees on the board, the more the fund shifts toward risky asset allocations. Overall, our results imply that political bias is likely costly to taxpayers and pension beneficiaries.