Financial Flexibility and Economic Policy Uncertainty: Evidence from Firm Behavior and Firm Value

Abstract

Economic policy uncertainty imposes a non-diversifiable risk on the firm. Our results show that financial flexibility is a formidable tool for firms in confronting economic policy uncertainty. Researchers have long considered financial flexibility a missing link in the literature as actual firm leverage is below the level predicted by traditional models. This study provides evidence that financial flexibility is valuable for firms. First, we find that financial flexibility is able to mitigate the negative relation between economic policy uncertainty and firm risk-taking activity. Second, financial flexibility moderates the negative effect of EPU on equity payouts. Third, our results show that financial flexibility enhances firm value in the face of economic policy uncertainty.

Keywords: Financial flexibility, Economic policy uncertainty, Unused debt capacity, Risk-taking activity, Equity payouts, Firm value, Exogenous shocks