How are economic policy uncertainty shocks transmitted to capital structure? Chinese evidence

Xiao-Ming Li and Mei Qiu

International Journal of Managerial Finance, 2022, vol. 19, issue 4, 910-929

Abstract: Purpose - The purpose of this paper is to investigate the mechanism of transmitting economic policy uncertainty (EPU) shocks to capital structure. Design/methodology/approach - The authors adopt a novel approach that bridges the asset pricing implications of EPU and the debt-financing decisions of Chinese firms by introducing a variable “policy-risk-induced equity return” (PRER). PRER is the product of the EPU beta and the EPU shock. Differentiating firms as per the signs of the EPU beta helps to shed light on the deep questions of whether their respective leverage targets and speeds of adjustment are different and how the targets and speeds are determined. Findings - The empirical evidence shows that it is the equity market that channels EPU shocks to capital structure through PRER in China. Firms with positive (negative) EPU betas have PRER impact negatively (positively) the leverage target, conforming to the market-timing theory. EPU and non-policy uncertainty shocks cause the speed of adjustment to change over time. Overall, the intertemporal relation between EPU and leverage is negative. These results are robust to alternative leverage measures and after controlling for non-policy uncertainty shocks and conventional firm characteristics and have implications for academic research, policymaking, market stability, and corporate financing. Originality/value - This study is the first to probe for, and provide insights into, the underlying reason why EPU impacts capital structure by connecting asset pricing to corporate financing for a large sample of Chinese publicly traded firms.

Keywords: Policy-risk-induced equity return; Leverage target; Speed of adjustment; Chinese firms; G31; G38 (search for similar items in EconPapers)
Date: 2022
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Persistent link: https://EconPapers.repec.org/RePEc:eme:ijmfpp:ijmf-02-2022-0079

DOI: 10.1108/IJMF-02-2022-0079

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