Journal of Credit Risk

Risk.net

Does economic policy uncertainty exacerbate corporate financial distress risk?

Jie Sun, Fangyuan Yin, Edward I Altman and Lewis Makosa

  • Economic policy uncertainty (EPU) is negatively related to financial distress risk (FDR).
  • When EPU is high, FDR can be reduced by reducing investment expenditure.
  • When EPU is high, FDR can be reduced by increasing cash holdings.

Economic policy uncertainty is an important factor determining the external environment of an enterprise, and it affects firm behavior, with consequences including financial distress risk. Using A-share listed companies on the Shanghai and Shenzhen Stock Exchanges in China from 2007 to 2017, this paper finds a negative relationship between economic policy uncertainty and distress risk. A mediating-effect test indicates that if uncertainty is high, enterprises will reduce the risk of financial distress by reducing investment expenditure and increasing cash holdings. Our paper adds to the literature on factors driving distress risk and the economic consequences of economic policy uncertainty, and it provides a basis for enterprises to respond to changes in policies.

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