Firm-level political risk and debt choice

Guan-Ying Huang, Carl Hsin-han Shen and Zhen-Xing Wu

Journal of Corporate Finance, 2023, vol. 78, issue C

Abstract: We examine the effect of firm-level political risk on debt choices and find: (i) firms with higher political risk display a preference for private debt over public debt; (ii) the magnitude of this preference varies with the aggregate policy uncertainty; (iii) politically risky firms indeed receive less favorable terms in the bond market. To explain such findings, we show that private lenders have several advantages in serving politically risky borrowers. First, to the extent that lenders cannot perfectly foresee the adoption of new government policies, private lenders' expertise in implementing the reorganization process is important to limit their potential loss. Second, politically risky borrowers must undertake significant operation adjustments facing rising policy uncertainty. Private lenders can gather accurate information and closely monitor these adjustments. Last, as the severity of political risk varies with aggregate policy uncertainty, there exists an implicit contract between a borrower and its relationship bank, whereby a borrower accepts less favorable terms during normal times in exchange for the bank's support during difficult times. Taken together, this study advances our understanding of how cross-sectionally heterogeneous political risk influences corporate debt choice.

Keywords: Political risk; Debt choice; Bank loan; Relationship banking (search for similar items in EconPapers)
JEL-codes: G21 G32 P16 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:corfin:v:78:y:2023:i:c:s0929119922001754

DOI: 10.1016/j.jcorpfin.2022.102332

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