Abstract
The authors show that there is a negative relationship between economic policy uncertainty (EPU) and firm overinvestment using Korean data from 2007 to 2016. Since Jensen (1986) shows that a firm's free cash flow is an important factor of overinvestment, the authors examine how free cash flow influences the sensitivity of overinvestment to EPU. The authors find that a high level of free cash flow attenuates the negative effect of EPU on overinvestment. The authors find that there is no significant difference in the effect of EPU on overinvestment between Chaebol (Korean family-run conglomerates) and non-Chaebol firms, which is consistent with the literature that the features of Chaebol are weakening.
Highlights
The investment-uncertainty relation has been one of the most interesting research topics for a long time
In line with the literature, we examine how economic policy uncertainty affects overinvestment using a sample of Korean firms
We infer from the existing literature that overinvestment is less sensitive to economic policy uncertainty (EPU) when firms have a higher level of free cash flow
Summary
The investment-uncertainty relation has been one of the most interesting research topics for a long time. From the effect of insider ownership on the relationship between investment and uncertainty, we infer that overinvestment is negatively related to EPU. Our second hypothesis is that the negative overinvestment-EPU relation is weaker for firms holding a higher level of free cash flow. We infer from the existing literature that overinvestment is less sensitive to EPU when firms have a higher level of free cash flow.
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