Economic policy uncertainty, corporate diversification, and corporate investment

ABSTRACT

This study explores the moderating role of corporate diversification between economic policy uncertainty (EPU) and corporate investment relationship. Using firm-level panel data of US firms over the period 2000–2020, we show that corporate diversification positively moderates the negative impact of EPU on corporate investment by reducing financial constraints. The analysis indicates that diversification mitigates the adverse impact of EPU on US firms’ investment. Furthermore, our results are robust to alternative proxies, subsample tests, selection bias, and endogeneity concerns. The findings are helpful from a managerial perspective, suggesting that diversification alleviates financial constraints, enabling firms to-- mitigate the negative impact of EPU on investment.

KEYWORDS:

• Economic policy uncertainty
• corporate investment
• corporate diversification
• US

JEL CLASSIFICATION:

• G30
• G38
• L25

Disclosure statement

No potential conflict of interest was reported by the author(s).

Data availability statement

Data for all the variables available from the data sources are mentioned in Table A1.

Notes

¹ The positive moderating role of corporate diversification between EPU-investment relationship is equally significant in small and large firms.

² The sample interval is selected to attain the maximum data availability of the main variables.

³ To reduce the effect of the possible outliers, we winsorized all the variables at the 1^st and 95^th percentile.

⁴ We provide variables definitions and summary statistics in Tables A1 and A2 appendices section, respectively.

⁵ In Eq. (1(1) $Cape{x}_{it}={\beta }_0+{\beta }_{1}EP{U}_t+{\beta }_{2}S{G}_{it}+{\beta }_{3}C{F}_{it}+{\beta }_4{Q}_{it-1}+{\beta }_{5}GDP.Growt{h}_t+{\gamma }_{firm}+{\epsilon }_{it}$(1) ), we only add the firm fixed effect as EPU has only time variation, and identification would be biased by adding a year fixed effect. See, for example (Suh and Yang 2021).

⁶ Since some industries rely more on government contracts than others (Baker, Bloom, and Davis 2016), we also estimated our results based on the industry fixed effect shown in Table A3 appendices section, using Thomson-Reuters Business classification 4-digit SIC codes. Except for a decrease in significance level, these results are qualitatively in line with baseline results, excluding Entropy measure of diversification, EPU × CD-EI, which is insignificant.

⁷ For brevity, we perform and discuss the mechanism, sensitivity, subsample, and additional control variable tests in appendices section from Table A6 to Table A9.

⁸ To quantify firms financial constraints, we proxy the financial constraints index developed by (Hadlock and Pierce 2010).