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Economic policy uncertainty, cost of capital, and corporate innovation

Zhaoxia Xu

Journal of Banking & Finance, 2020, vol. 111, issue C

Abstract: We examine the impact of government economic policy uncertainty (GEPU) on corporate innovation and identify a cost-of-capital transmission channel. We find that GEPU increases firms’ cost of capital, which translates into lower innovation. As economic policy uncertainty rises, firms with more exposure to such uncertainty face a higher weighted average cost of capital and innovate less. Innovations of financially constrained firms and firms relying on external finance in a competitive environment are affected more. Our study provides novel evidence that higher economic policy uncertainty hinders innovation not only through the traditional investment irreversibility channel, but also through the cost-of-capital channel.

Keywords: Economic policy uncertainty; Implied cost of equity; Cost of debt; Innovation (search for similar items in EconPapers)
JEL-codes: G31 G32 G38 O30 M41 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.jbankfin.2019.105698

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