Firm-level political risk and debt choice

Guan-Ying Huang, Carl Hsin-han Shen*, Zhen-Xing Wu

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

3 Citations (Scopus)

Abstract

We examine the effect of firm-level political risk on debt choices and find: (i) firms with higher political risk display a preference for private debt over public debt; (ii) the magnitude of this preference varies with the aggregate policy uncertainty; (iii) politically risky firms indeed receive less favorable terms in the bond market. To explain such findings, we show that private lenders have several advantages in serving politically risky borrowers. First, to the extent that lenders cannot perfectly foresee the adoption of new government policies, private lenders' expertise in implementing the reorganization process is important to limit their potential loss. Second, politically risky borrowers must undertake significant operation adjustments facing rising policy uncertainty. Private lenders can gather accurate information and closely monitor these adjustments. Last, as the severity of political risk varies with aggregate policy uncertainty, there exists an implicit contract between a borrower and its relationship bank, whereby a borrower accepts less favorable terms during normal times in exchange for the bank's support during difficult times. Taken together, this study advances our understanding of how cross-sectionally heterogeneous political risk influences corporate debt choice.
Original languageEnglish
Article number102332
Pages (from-to)1-25
Number of pages25
JournalJournal of Corporate Finance
Volume78
DOIs
Publication statusPublished - Feb 2023

Keywords

  • Political risk
  • Debt choice
  • Bank loan
  • Relationship banking

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