Research Handbooks in Business and Management series
Edited by Hemant Merchant
Chapter 15: Government policy uncertainty and corporate investment in emerging markets
Today, in order to remain viable and profitable, firms compete not only against other domestic firms but also against multinational firms to maintain existing businesses and/or engage in new and more profitable businesses. In much of the existing corporate investment literature (Dasgupta and Sengupta, 2007; Fama, 1970; Innes, 1991; Lucas and Prescott, 1971; Modigliani and Merton, 1958; Moyen, 2004; Myers and Majluf, 1984), firms are often believed to take into account the degree of uncertainty when making investment decisions, and few are believed to make investment decisions without considering political risk (Bilson et al., 2002; Busse and Hefeker, 2007; Jiménez, 2010). However, few empirical studies have explicitly taken into account the influence of government policy uncertainty on corporate investment. While the idea that corporate investment tends to be industry-specific and dependent on market-wide conditions (e.g., procyclical or countercyclical) is perhaps well accepted in the literature, from my casual observations of the variation in corporate investment in emerging market countries, I see a different picture, with (1) the degree of political risk, on average, higher in developing countries than in advanced countries (Bilson et al., 2002), (2) higher political risk increasing firms’ financial leverage (Kesternich and Schnitzer, 2010), and (3) financial leverage negatively associated with investment (Ahn et al., 2006).
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