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Publication Policy uncertainty, investment, and the cost of capital

Type

Working Paper

Institution(s)

University of Hamburg, University of Alberta, University of South Carolina

Year

2017

Author(s)

Wolfgang Drobetz, Sadok El Ghoul, Omrane Guedhami, Malte Janzen

Research Area

Corporate Finance

Keywords

Economic uncertainty, policy uncertainty, investment, cost of capital

Abstract

We examine the effect of economic policy uncertainty on the relation between investment and the cost of capital. Using a novel news-based index developed by Baker, Bloom, and Davis (2016) for 18 countries, we find that the strength of the negative relation between investment and the cost of capital decreases in times of high economic policy uncertainty. For the subsample of U.S. firms, we find similar effects for CPI and tax-related policy uncertainty. Our results further suggest that an increase in policy uncertainty reduces the sensitivity of investment to the cost of capital the most for small firms and for industries that depend more strongly on government subsidies and government consumption. We conclude that economic policy uncertainty distorts the fundamental relation between investment and the cost of capital.

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