High Economic Policy Uncertainty Research Articles

Does economic policy uncertainty impact firms' capital structure policy? Evidence from Western European economies.

This study specifically investigates the impact of economic policy uncertainty (EPU) on travel and leisure (TL) companies' debt holdings policy. To the best of our knowledge, there is a momentous gap in exclusively conducting the impact of EPU on the debt holdings policy behavior of Western European firms operating in the TL sector and its sub-sectors, namely the airlines, gambling, hotels, recreational services, restaurants and bars, and travel and tourism. In this sector, external financing is strongly needed to finance enormous investments and replace, expand, and modernize tangible and intangible assets. To fill the gap, the present study selects 92 publicly listed TL companies operating in Western Europe's top tourist destinations, namely, the UK, Germany, France, Spain, and Italy, and performs both the static and dynamic panel data estimation approaches during the 2005-2019 period. The results reveal that the EPU negatively impacts TL firms' debt holdings, implying that firms tend to decline in debt levels by rising EPU. Consequently, the results highlight that the level of EPU matters, and firms' debt ratios are relatively lower in countries having a higher EPU and vice versa. Besides, the results underscore that the EPU negatively impacts firms' debt holdings in each sub-sector; however, the negative effect is most prominent on the debt ratios of the firms, particularly those operating in gambling, hotels, travel, and tourism, and also recreational services sub-sectors. The results are robust and have important suggestions for regulatory bodies, policymakers, and firms' managers.

Economic policy uncertainty and mutual fund risk shifting

This study examines the effect of economic policy uncertainty (EPU) on mutual fund risk shifting. Using Chinese mutual fund data from 2006 to 2020, we find that managers increase risk-shifting activities when uncertainty rises. A one-standard-deviation increase in EPU is associated with a 0.27- to 0.55-standard-deviation increase in risk shifting. Managers’ tendency to shift risk stems from poor performance during high EPU periods. Managers increase the portfolio risk by switching from cash holdings to equities, engaging in sector rotation, and increasing bubble stock holdings.

Uncertainties and disagreements in expectations of professional forecasters: Evidence from an inflation targeting developing country

AbstractThis paper investigates whether news‐based measures of economic uncertainty affect professional forecasters' disagreement about economic variables and economic policy instruments in Brazil. With the use of an “Economic Policy Uncertainty” index and a “Media Uncertainty” index to construct an index of economic uncertainty unrelated to policy, we study the effects of economic policy uncertainty and policy‐unrelated economic uncertainty on professional forecasters' disagreement. With the use of data from January 2002 to January 2021, we find that disagreements in expectations increase with both higher economic policy uncertainty and higher policy‐unrelated economic uncertainty. An exception is disagreement about future inflation, corroborating the importance inflation targeting for anchoring inflation expectations. We further show that economic policy uncertainty affects disagreement about Brazilian fiscal policy, whereas it does not affect disagreement about Brazilian monetary policy.

Management buyouts in times of economic policy uncertainty

Using a sample of 18,225 global buyouts, we find that management buyouts (MBOs) are significantly more likely to occur if economic policy uncertainty (EPU) increases. This finding is consistent with the idea that EPU provides an opportunity for insiders to capitalize on private information and time the market. Further results suggest that market timing pays off on average. We find that MBOs achieve more favorable buyout prices and greater post-buyout operating improvements than institutional buyouts during times of high EPU. Our results hold when exploiting close national election races as a quasi-natural experiment for EPU.

The Impact of China’s Overseas Emigration Network on Outward Foreign Direct Investment

ABSTRACT Emigrants can reduce information asymmetry and provide community enforcement of contracts across international boundaries. This study investigates the impact of China’s overseas emigration network on OFDI with a particular focus on the intensive and extensive margins of OFDI. Using data from 116 countries during the 2005–2019 period, we find that more emigrants in a given country promote both the intensive and extensive margins of OFDI and thus promote OFDI into that country. Furthermore, we find that the positive effects of the emigration network on OFDI only exist among non-high income host countries and non-Belt and Road host countries. Finally, during periods of high global economic policy uncertainty, the positive effect of the emigration network on the extensive margin and OFDI is mitigated.

Can Fulfillment of Social Responsibility Enable Enterprises to Innovate? The Role of Corporate Financialization and Agency Costs

This study constructs a panel model to conduct an empirical analysis on the influence of fulfillment of social responsibility on corporate innovation and its mechanism based on the annual data of A-share listed companies in China from 2010 to 2020. Research results show that (1) fulfillment of social responsibility has a positive effect on corporate innovation. Compared with enterprises with high economic policy uncertainty and low equity balance and non-state-owned enterprises, the implementation of social responsibility has a larger impact on the innovation of enterprises with low economic policy uncertainty and high equity balance and state-owned enterprises. (2) Corporate financialization and agency costs play a mediating role in the relationship between fulfillment of social responsibility and corporate innovation. Fulfillment of social responsibility can promote enterprise innovation by alleviating the capital-crowding effect caused by enterprise financialization and reducing agency costs. (3) Commercial credit has a positive moderating effect on the relationship between fulfillment of social responsibility and enterprise innovation. (4) Institutional investors have a negative moderating effect on the relationship between the fulfillment of social responsibility and enterprise innovation. The results can provide important theoretical guidance and serve as a decision-making reference for standardizing corporate social responsibility behavior and realizing the high-quality development of the Chinese economy.

Political connections and economic policy uncertainty: A global evidence

Crony capitalism literature finds that political connections are either positively or negatively associated with various firm outcomes. However, the relationship between political connections and country level variables remains under-explored. Motivated by this gap of knowledge, our study investigates the relationship between political connections around the world and economic policy uncertainty (EPU). Our evidence suggests that the likelihood for political connections to be established is higher in countries with high EPU compared to those with low EPU. Additionally, the findings also indicate that heightened state of EPU mitigates the ability of strong institutional governance to reduce political connections.

Economic policy uncertainty and firm propensity to invest in corporate social responsibility

PurposeThis study aims to examine the impact of economic policy uncertainty (EPU) on firm investment in corporate social responsibility (CSR)’s environmental, social and governance (ESG) dimensions. Additionally, the study examines whether firm size moderates the EPU–CSR relationship.Design/methodology/approachThe sample includes 2,017 US. firms from 2002 to 2018. Data on ESG scores are drawn from the Asset-4 database in Thomson Reuters to measure CSR investment. ordinary least square regression, including fixed effects at the year and industry level, is used as the main econometric specification. Moreover, the study employed the two-step system Generalized Method of Moments to address the endogeneity concerns.FindingsThe findings reveal that firms increase their CSR investment in response to high EPU. The results are consistent in all the three ESG/CSR dimensions: ESG. Moreover, the positive association between EPU and CSR is driven by firm size, indicating that large-sized firms have the resources and incentives to invest more in CSR. Our main findings remain consistent after addressing the endogeneity concerns and controlling for the effect of omitted variable biasness.Originality/valueUsing a unique sample of US firms, this study empirically contributes to the current literature on the association between EPU and CSR investment. Moreover, firm size plays a vital role in moderating this relationship.

Does economic policy uncertainty affect bank profitability?

PurposeManagers are concerned about how the macroeconomic environment affects business profit. Focusing on banks, this study aims to investigate the effect of economic policy uncertainty (EPU) on bank profitability in 22 advanced countries.Design/methodology/approachThe study used the panel fixed effect regression methodology to assess the effect of EPU on several measures of bank profitability for 22 advanced countries from 1998 to 2017. The measures of bank profitability are net interest margin, lending-deposit spread, non-interest income (NII) ratio, after-tax return on asset, before-tax return on asset, after-tax return on equity and before-tax return on equity.FindingsThe findings reveal that high EPU negatively affects bank NII. Real gross domestic product growth rate, nonperforming loans and regulatory capital ratio are negatively related to profitability in times of high EPU. The findings also reveal that high EPU has a positive effect on bank profitability in Asia and the region of the Americas, as these regions witnessed high return on equity in times of high EPU.Practical implicationsThe implication of the findings is that, although EPU has a depressive effect on some indicators of bank profitability, regional characteristics can ameliorate the depressive effects of EPU on bank profitability.Originality/valueThis study contributes to the literature that examine the economic consequences of EPU on firms. To the best of the authors’ knowledge, this study is among the first to examine how regional characteristics affect the relationship between EPU and bank profitability using cross-country data.

Why Firms in Concentrated Industries are Overpriced in China?

ABSTRACT Firms in concentrated industries (FCIs) might not be as valuable as they priced. Using a product-based monopoly measure for individual firms, we find that FCIs are prone to being overpriced in China stock market. This overpricing cannot be dismissed by varying proxies for arbitrage constraints and risks. Alternatively, it can be attributed to immoderate optimism on FCIs. In line with the optimism explanation, we find that FCIs suffer more serious fundamental declines in high economic policy uncertainty periods and that, the overpricing is corrected during earning announcements. These findings are robust across alternative model specifications and variable constructions.

Economic policy uncertainty and debt allocation within business groups

A business group operation, as a strategic organizational form, is critical for corporate development. However, how business groups allocate their debt between parent and subsidiary companies remains an unexplored issue. This study explores the impact of economic policy uncertainty (EPU) on debt allocation within business groups. In theory, when business groups encounter high EPU, they can choose either a centralized or a decentralized debt structure. We find that Chinese business groups under EPU tend to choose centralized borrowing, especially for non-state-owned enterprises and business groups with low-quality internal controls and volatile profitability. Our findings highlight the significance of EPU in determining the allocation of decision rights within business groups.

Policy uncertainty sensitivity, COVID-19 and industry returns in the United States

This paper examines if industries with higher economic policy uncertainty (EPU) sensitivity also respond differently to the evolution of COVID-19 pandemic. Initially, industries are allocated into decile portfolios according to their sensitivity to the US-EPU shocks, then portfolio returns are conditioned against changes in daily cases and deaths, respectively. After controlling for the standard risk-factors of equity returns, neither the cases nor deaths can load significantly against the returns of portfolio with the highest negative EPU exposure. However, industries which respond positively to the US-EPU shocks also respond positively to increases in cases and deaths.

Opportunity for whom: economic policy uncertainty, managerial ability and firm value

ABSTRACT Different from the overwhelming evidence in support of the negative effect of economic policy uncertainty on firm value, our findings show that economic policy uncertainty has positive impact on firm value in firms with high managerial ability using the firm-level data from China over the time period 2003 to 2020. Moreover, our mechanism analyses reveal that firms with high managerial ability differ from those with low managerial ability by conducting more acquisitions and innovation activities and improving cost efficiency when faced with high economic policy uncertainty.

How does the economic policy uncertainty affect the relationship between financial slack and firm performance in emerging countries?

This study investigates the moderating effect of economic policy uncertainty (EPU) on the relationship between slack resources and firm performance in emerging countries. By using 47,523 firm‐year observations from seven emerging market economies through the period of 2010–2018, the results show an inverse U‐shaped relationship between slack resources and firm performance. The findings also demonstrate that EPU acts as a negative moderator for the slack–performance relationship. In high EPU environments, the marginal benefit from one additional unit of slack is smaller relative to low EPU environments. This study contributes to the slack resources‐firm performance literature by emphasizing the role of the broader external environment as a moderator.

Economic policy uncertainty and government spending multipliers

We examine the impact of Economic Policy Uncertainty (EPU) on the effectiveness of government spending using a local projection method with an endogenously determined threshold parameter. The empirical analysis reveals that government spending multipliers are larger during low EPU periods compared to those in high EPU periods. This result is robust when government spending shocks are identified using government spending news constructed based on survey of professional forecasters data. Our study calls for policy expectation management as a company effort together with fiscal stimulus.

How does economic policy uncertainty influence managers' learning from peers' stock prices? Evidence from China

This paper investigates the impact of economic policy uncertainty (EPU) on firms' investment sensitivity to their peers' stock prices. We find that investment increasingly responds to the variation of peers' prices during the high policy uncertainty period in China. To deal with the increasing uncertainty, managers need more information for investment decisions and thus are motivated to learn from the prices of their peer firms. Empirical evidence shows that the positive effect is more pronounced for firms with higher operating uncertainty, lower price informativeness, and limited access to economic policy, which supports our managerial learning hypothesis. Further discussions suggest that when EPU is heightened, the relationship between firms' investment and peers' prices is more significant for better-governed, less financially constrained, and more policy uncertainty exposed firms. And the investment of followers is sensitive to leaders' prices, but not vice versa. We also document investment influenced by peer learning is conductive to firm value in high EPU periods. Our study highlights the importance of policy uncertainty in explaining managers' incentives to learn from peer firms.

Of votes and viruses: the UK economy and economic policy uncertainty

ABSTRACT This paper examines the relation between GDP growth, Divisia money growth, CPI inflation, financial stress, and the UK's economic policy uncertainty in the context of its departure from the European Union. We employ two Bayesian VAR models which account for the extreme observations in macroeconomic and financial time series resulting from the COVID-19 pandemic outbreak. We document a contractionary effect of an economic policy uncertainty shock on GDP growth, which is not present in a model which does not account for the COVID-19-related outliers. Additionally, we find that GDP growth is enhanced by Divisia monetary stimulus but hampered by increases in financial stress. The results from a stochastic volatility in the mean threshold model also uncover different dynamics of transmission of shocks between economic uncertainty and the indicators we study across high and low economic policy uncertainty regimes.

Strategic archetypes, credit ratings, and cost of debt

Despite the theoretical and empirical controversy about rating agencies' reputational issues, credit ratings have far-reaching implications for financing and investment decisions. However, the relationship between strategic behavior and credit ratings remains largely unexplored. Using a large sample of U.S. non-financial firms between 1981 and 2016, we examine how established archetypes of strategic behavior in business affect firms’ credit ratings. We document that firms with prospector type strategies experience significantly lower credit ratings than firms which are identified as defenders and analyzers. The negative effect on credit ratings is more pronounced for firms operating in weaker governance environments and during periods of high economic policy uncertainty. Further, we find that prospector type firms with weaker credit ratings have a higher cost of debt. Our results hold after accounting for endogeneity concerns and self-selection bias. Overall, our findings emphasize that more transparent and stringent governance can enhance ratings of prospector firms.

Asymmetric effects of economic policy uncertainty on Bitcoin’s hedging power

PurposeEven though Bitcoin has been often labelled as a safe haven asset class in the literature, the influence of economic policy uncertainty (EPU) on the diversifying opportunities offered by Bitcoin in relation to other assets needs to be investigated. This paper aims to investigate how the EPU affects diversification of commodity, conventional, Islamic and sustainable equity returns in relation to its impact on Bitcoin returns.Design/methodology/approachThe authors use advanced time-series econometrics, namely, multivariate generalized autoregressive conditional heteroscedastic-dynamic conditional correlation and continuous wavelet transformation, for the analysis of the daily returns for the aforementioned assets between 01 August 2011 and 01 September 2019.FindingsFirst, the authors found a strong evidence of Bitcoin’s mean reverting trend in the long run while its volatility has decreased significantly since 2013. After separating the EPU into two regimes (high and low), diversification opportunities with Bitcoin seems to disappear in a high EPU period, while the hedging opportunity tends to prevail in a low EPU period for all classes of assets. Importantly, the findings indicate that Bitcoin offers short-term diversification for sustainable and Islamic equity as well as energy stocks during a low uncertainty period. Consequently, in relation to the policy uncertainty, Bitcoin provides similar hedging opportunities than commodities like Gold and Silver. Overall, the study shows that EPU is remarkably important in explaining the average portfolio returns of Bitcoin, suggesting that this indicator can be perceived as a decent explanatory factor for portfolio diversification.Originality/valueThe study significantly extends the empirical literature of Bitcoin’s portfolio diversification by taking EPU into consideration. To the best of authors’ knowledge, this is one of the few studies to investigate the asymmetric effects of US EPU on Bitcoin’s hedging capabilities by taking into account major conventional equity, sustainable equity, Islamic equity, gold, silver and oil.

Curvilinear effect of economic policy uncertainty on innovation in Chinese manufacturing firms: do managerial pay gaps matter?

PurposeThis study aims to re-examine the impact of economic policy uncertainty (EPU) on firm innovation. Studies on how EPU affects firm innovation have been inconclusive. The authors clarified the curvilinear relationship between EPU and firm innovation and examined the moderating effects of managerial pay gaps, specifically vertical pay disparity and horizontal pay dispersion.Design/methodology/approachThis study’s analyses used data collected from Chinese listed companies from 2007 to 2019.FindingsThe authors found an inverted U-shaped relationship between EPU and firm innovation. Furthermore, vertical pay disparity strengthens the curvilinear relationship, while horizontal pay dispersion weakens it.Practical implicationsFirst, politicians should avoid adjusting economic policies too frequently because the high EPU levels created by frequent adjustments can inhibit business innovation. Second, firms should be aware that EPU creates opportunities for leapfrogging. In particular, firms can incentivize executives to take advantage of the valuable growth opportunities presented by EPU by widening vertical pay disparities and avoiding excessive horizontal pay dispersion.Originality/valueFirst, the authors analyze not only the positive effects of lower EPU on firm innovation but also the negative impacts of higher EPU to examine EPU’s “double-edged sword” effect on firm innovation. Second, the investigation of vertical pay disparity and horizontal pay dispersion as moderating variables sheds new light on the equivocal research findings regarding the EPU–firm innovation relationship and clarifies the boundary conditions of the double-edged sword effect of EPU on firm innovation.