Policy Uncertainty, Investment, and the Cost of Capital

59 Pages Posted: 6 Jun 2017 Last revised: 30 Aug 2018

See all articles by Wolfgang Drobetz

Wolfgang Drobetz

Hamburg University

Sadok El Ghoul

University of Alberta - Campus Saint-Jean

Omrane Guedhami

University of South Carolina - Moore School of Business

Malte Janzen

University of Hamburg

Date Written: October 5, 2017

Abstract

We examine the effect of economic policy uncertainty on the relation between investment and the cost of capital. Using the news-based index developed by Baker, Bloom, and Davis (2016) for twenty-one countries, we find that the strength of the negative relation between investment and the cost of capital decreases during times of high economic policy uncertainty. An increase in policy uncertainty reduces the sensitivity of investment to the cost of capital most for firms operating in industries that depend strongly on government subsidies and government consumption as well as in countries with high state ownership. Consistent with the price informativeness channel, we find that an increase in policy uncertainty reduces the investment-cost of capital sensitivity for firms from more opaque countries, firms with low analyst coverage, firms with no credit rating, and small firms. We conclude that economic policy uncertainty distorts the fundamental relation between investment and the cost of capital.

Keywords: Economic Uncertainty, Policy Uncertainty, Investment, Cost of Capital

JEL Classification: P16, G32

Suggested Citation

Drobetz, Wolfgang and El Ghoul, Sadok and Guedhami, Omrane and Janzen, Malte, Policy Uncertainty, Investment, and the Cost of Capital (October 5, 2017). Journal of Financial Stability, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2980918 or http://dx.doi.org/10.2139/ssrn.2980918

Wolfgang Drobetz

Hamburg University ( email )

Moorweidenstrasse 18
Hamburg, 20148
Germany

Sadok El Ghoul

University of Alberta - Campus Saint-Jean ( email )

Edmonton, Alberta T6G 2R3
Canada
780-465-8725 (Phone)
780-465-8760 (Fax)

Omrane Guedhami

University of South Carolina - Moore School of Business ( email )

Columbia, SC
United States

Malte Janzen (Contact Author)

University of Hamburg ( email )

Moorweidenstraße 18
Hamburg, 20148
Germany

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