Uncertainty, Stock Prices, and Debt Structure: Evidence from the U.S.-China Trade War

Abstract

Using the 2018-2019 U.S.-China trade war as a laboratory, we establish the casual relation that policy uncertainty shocks significantly lower stock prices. In addition, we find that the usage of bank debt in firms' debt structure can significantly mitigate the negative impact, while the mitigating effect does not exist for non-bank debt. We further demonstrate the source of the mitigating effect by showing that it is concentrated among zombie firms --- mature firms that persistently do not have enough earnings to cover their interest expenses. A zombie firm that derives half of its capital from bank debt can offset the negative impact of uncertainty entirely due to the mitigating effect. Our findings provide evidence that bank debt can provide insurance and flexibility for shareholders of distressed firms, especially during turbulent times.

Keywords: Policy uncertainty; trade war; asset prices; debt structure; zombie firms

JEL Classification: E44, F13, G12, G20, G30