The Moderating Effect of Financial Constraint on the Relationship between Economic Policy Uncertainty and Corporate Financialization

Corporate financialization has attracted significant attention from researchers due to its implications for financial stability, economic growth, and income inequality. This phenomenon is profoundly influenced by economic uncertainty and the financial constraints faced by firms. The primary objective of this study was to investigate how financial constraints moderated the relationship between economic policy uncertainty and corporate financing decisions. The sample comprised 125 companies listed on the Tehran Stock Exchange (TSE). Appropriate regression analyses were conducted following preliminary tests. The findings indicated that economic policy uncertainty had led to a substitution effect between business investment and financial investment. Furthermore, financial constraints were identified as a moderating factor in the relationship between economic policy uncertainty and corporate financing decisions. Additionally, different types of firms demonstrated varying levels of sensitivity and responsiveness to economic policies under diverse economic conditions.
Keywords: Company Financialization, Economic Policy Uncertainty, Financial Constraints.
JEL Classification: D04, D81, G38
 
In recent years, the real economy has faced unprecedented pressures and risks, resulting in declining investment returns. Concurrently, financial development has increasingly diverged from its role of supporting the real economy, leading to an accumulation of funds within the financial system (Tang & Zhang, 2019). Various factors influence corporate financing; however, these factors cannot be detached from the broader macroeconomic environment. Governments often implement economic reform policies that heighten uncertainty regarding economic policies and increase volatility in financial markets. This raises a critical question: How does economic policy uncertainty influence the allocation of financial assets by companies and how does this, in turn, promote corporate financialization? Previous studies have shown that companies frequently adjust their investment strategies during periods of financial crisis and heightened uncertainty surrounding economic policies (Durnev, 2010). While existing literature has explored the effects of economic uncertainty on various business decisions, such as increasing cash holdings, reducing capital expenditures, and engaging in merger and acquisition activities, there is a notable gap in research specifically addressing the impact of economic uncertainty on corporate financing (Nguyen & Phan, 2017; Gulen & Ion, 2016). Recent empirical studies emphasize the critical role of financial constraints in moderating the effects of economic policy uncertainty on corporate financing. Firms facing financial constraints, such as limited access to external financing, may exhibit heightened sensitivity to economic policy uncertainty, leading to a greater reliance on financing as a risk mitigation strategy (Chun et al., 2023). This study aimed to enhance the existing literature on economic policy uncertainty from the perspective of corporate financing while providing new empirical evidence to elucidate the U-shaped relationship between economic policy uncertainty and corporate financing in emerging markets.
 
 
Materials & To determine the appropriate model for estimating the research framework, the Hausman and Limmer tests were employed, while the Breusch-Pagan test was used to assess heteroscedasticity. The Jarque-Bera test was applied to evaluate the normality of the residuals. To establish the reliability of the research variables, the Levin, Lin, and Chu tests were conducted. Given the significance of the variables, it could be concluded that the regression models designed for hypothesis testing were valid. The independent variable in this study was economic policy uncertainty defined as a situation in which the probabilities of future events are indeterminate; even when potential events are known, their associated probabilities remain uncertain. Following the methodologies of Demir (2009), Tang and Zhang (2019), and Zhou and Guo (2021), this study measured firm financialization using the ratio of financial assets held by firms (i.e., the ratio of financial assets to total assets). Financial assets encompass a range of items, including money market funds, commercial financial assets, marketable securities, held-to-maturity investments, derivative financial instruments, net loans and advances, long-term equity investments, real estate, and dividend and interest receivable.
 
The findings indicated that when economic policy uncertainty remained within an optimal range, an increase in such uncertainty could stimulate business investment in tangible assets rather than in financial assets. Conversely, extremely high levels of economic policy uncertainty might lead companies to increase their investments in financial assets. However, excessive investment in financial assets could negatively impact the real economy. Therefore, it was essential for the government to enhance the transparency of its macroeconomic policies and adopt flexible transitions in economic policy to mitigate the adverse effects of excessive financialization, particularly during periods of economic downturn. Simultaneously, companies had to critically assess the risks and opportunities arising from economic policy uncertainty and make informed investment decisions. Furthermore, the findings revealed that financial constraints influenced the relationship between economic policy uncertainty and corporate financialization. This suggested that different types of firms exhibited varying degrees of sensitivity and responsiveness to economic policies under diverse economic conditions. Consequently, these factors had to be taken into account when evaluating the impact of economic policy uncertainty. Firms facing significant financial constraints might need to adjust their capital structures by reallocating financial assets to maintain normal business operations through cash flow management. In contrast, when economic policy uncertainty was high, firms with lower financial constraints might experience reduced operational risks and could leverage their financial resources to invest in financial assets for potentially higher returns.
 
Discussion & The findings offer valuable insights for policymakers aiming to manage corporate financial levels and mitigate the risk of financial crises. Given the significant impact of economic policy uncertainty on corporate financialization, Iranian policymakers should recognize its adverse effects on the real economy and work to reduce this uncertainty in order to foster a stable business environment for enterprises. Additionally, the government should collaborate with businesses to enhance their financialization channels. When management has access to reliable and substantial financialization services, the likelihood of excessive reliance on financialization products diminishes. Finally, greater attention should be directed toward small enterprises, non-governmental organizations, poorly governed companies, and those experiencing slower growth. These entities often face greater financial constraints and are less equipped to navigate the financial processes necessary for sustainable operations.