Economic Policy Uncertainty & Cost Of Debt Financing: International Evidence GROUP MEMBERS MALAIKA IMRAN RIMSHA RAZZAQ MAIN THEME OF PAPER THE FOCUS OF THE PAPER: Economic policy affects Corporate financial decisions Two main variables are Economic policy uncertainty Sample Cost of debt financing 163,243 observations Two mechanisms 23,602 firms Asymmetry risk 17 countries Default risk 2003-2016 RESEARCH GAP Previous studies and GAP: Studies explain political uncertainty may influence cost of debt financing but they fail to show directly whether economic policy uncertainty influence cost of debt Studies are conducted only in one country thus fail to show how economic policy influences cost of debt across countries. HYPOTHESIS H1: Economic policy uncertainty is positively related to cost of debt. H2: The effect of economic policy uncertainty is stronger during the crises period. RESEARCH VARIABLES Dependent variable Exploratory variable Control variable Firm level other control variable Country- level other control variable ASSUMPTION Firms years meeting the following criteria were eliminated from the study: 1) Firms-years with negative values of total assets ,equity, sales revenue and liabilities. 2) Firm-years belong to financial sector and utilities industry according to the standard industrial classification (SIC). 3) Firms with multiple issues of common stocks. 4) Firm-years without consolidated financial reports and missing information. RESEARCH RESULTS Economic policy uncertainty is positively related to cost of debt. The effect of political uncertainty on cost of debt is transmitted through policy uncertainty. High economic policy uncertainty increases default risk, and information asymmetry between firms and creditors. Therefore, creditors tend to increase cost of debt. The financial crisis dummy is also positively associated with corporate debt financing cost. Firms face higher cost of debt during the crisis period since bank credit is less available and economic uncertainty is higher. Operating cash flow, Tobin’s Q are negatively related to cost of debt while financial leverage is positively correlated with cost of debt. RESEARCH RESULTS Firms with high operating cash flow, high Tobin’s Q (growth opportunities) and low financial leverage have low risk of default; therefore, they face low cost of debt. Asset tangibility positively affects cost of debt financing. Firms with high asset tangibility are more capable to borrow money since they may use tangible assets as collateral. They are more likely to have high default risk and they face higher cost of debt. Inflation and real interest are higher, firms face higher cost of debt. Large firms have better reputation, controlling system and bank relationship; therefore, they have better access to external funds with lower costs. When facing high economic policy uncertainty that may lead to higher cost of debt, the characteristics of large firms help them reduce the increase in cost of debt. Firm size mitigates the effect of economic policy uncertainty on corporate debt financing. CONCLUSION High economic policy uncertainty leads to higher default risk and more severe information asymmetry between firms and creditors; consequently, creditors increase cost of debt. Political uncertainty may influence cost of debt through economic policy uncertainty. The effect of economic policy uncertainty on cost of debt is stronger during the global financial crisis from 2008 to 2009. Economic uncertainty during the crisis make creditors focus more on the role of economic policy uncertainty in valuing cost of debt. Large firms’ debt financing cost is less affected by economic policy uncertainty. RECOMMENDATION Managers should take economic policy uncertainty into account when making financing decisions and use more internal funds when economic policy uncertainty is high. Policy makers should reduce economic policy uncertainty in order to improve economic efficiency. Especially, during a financial crisis the government should help firms reduce their financing costs.
