The Effect of Economic Policy Uncertainty on Firms' Leverage: Evidence from China

Abstract

In the past several decades, economic policy uncertainty (EPU) has upsurged around the world. We explore the impact of EPU on leverage ratio in this empirical study. We carry out our research by linear regression models whose control variables involve main firm-level financial and operation indicators as well as dummy variables of year and industry to control their influences. The sample is obtained based on the listed companies from China. It turns out that the leverage ratio is negatively associated with EPU significantly. This negative relation is robust to a series of robustness checks. Further extended heterogeneity analyses manifest a significant differentiation among the listed companies. Although at a general firm level, increasing uncertainty that firms face in external economic policy will lead to a decrease in leverage, companies of state-owned or of a larger scale tend to increase their leverage, since they have stronger competence against risks and uncertainty. Otherwise, the leverage will decrease, then. From this macro perspective to examine firms' decision-making process, our conclusions can enhance the institutional mechanisms to affect single companies and provide insights for policymakers to devise deleveraging policies and improve micro corporate governance.