Firm-level political risk and debt choice

     Uncertainty surrounding government policies can profoundly affect firms’ investment and financing decisions. However, the same policy may have markedly different effects across firms. This study adopts a firm-level political risk perspective to examine how firms choose between private debt, such as bank loans, and public bonds when facing political and policy uncertainty. Unlike prior studies that primarily measure political risk using aggregate economic policy uncertainty, we emphasize substantial heterogeneity in political risk across firms and investigate how such heterogeneity shapes corporate debt structure.      We employ the firm-level political risk measure developed by Hassan et al. (2019), which uses textual analysis of earnings conference call transcripts of U.S. public firms to capture individual firms’ exposure to changes in government policy. We combine this measure with data from Capital IQ, Compustat, FISD, and DealScan to construct measures of firms’ debt structures and financial characteristics. Our final sample consists of 27,388 firm-year observations representing 3,198 U.S. public firms from 2001 to 2016. The results first show that firms facing greater political risk rely more heavily on private debt, particularly bank loans, and less on public bonds. The effect is both statistically and economically significant: an increase in firm-level political risk from the first to the third quartile is associated with an increase in the bank-loan-to-total-debt ratio equivalent to approximately 4.8% of its sample median. This relation remains robust after controlling for aggregate economic policy uncertainty and conventional credit risk factors, suggesting that firm-level political risk has a distinct influence on corporate financing decisions. Second, we find that firms with greater political risk receive less favorable financing terms in the public bond market, including higher issuance yields and lower credit ratings. Interestingly, bonds issued by these firms subsequently earn higher returns in the months following issuance, suggesting that public bond investors may initially overreact to issuers’ political risk. Consequently, firms facing greater political risk tend to reduce their reliance on public bond markets and turn instead to bank financing.      Our analysis further identifies three important advantages that enable private lenders, particularly banks, to serve firms exposed to high political risk. First, banks possess superior restructuring capabilities, allowing them to mitigate potential losses when policy changes adversely affect borrowers. Second, banks can obtain borrower-specific information through direct communication and continuously monitor firms, giving them an advantage when information asymmetry is severe. Third, banks and firms can develop long-term lending relationships. Firms may accept less favorable financing terms during relatively stable periods in exchange for continued bank support when policy uncertainty rises. Consistent with this relationship-banking mechanism, we find that politically risky firms rely more heavily on relationship loans during periods of high policy uncertainty and receive loans with lower spreads, longer maturities, larger amounts, and fewer covenants.      A main contribution of this study is to shift the analysis of political risk from the aggregate level to the firm level. Even when firms operate within the same country and face the same policy environment, their exposure to policy changes can differ substantially. Relying solely on country-level or aggregate policy uncertainty measures may therefore overlook important cross-sectional heterogeneity. Our findings demonstrate that firm-specific exposure to political risk materially affects firms’ financing sources and debt structures. This study also deepens our understanding of the economic role of banks. Banks are not merely a source of corporate funding. When firms face difficult-to-predict policy risks, banks’ advantages in information acquisition, ongoing monitoring, debt restructuring, and relationship lending enable them to provide services that are difficult for public bond markets to replicate. Overall, our findings suggest that when political and policy uncertainty increases, corporate financing decisions involve more than simply choosing the least costly source of capital; they also reflect how firms use banks’ informational and relationship advantages to manage political risk. These findings extend the literature on corporate political risk and debt structure and enhance our understanding of the important role of banks in supporting corporate financing and financial resilience in highly uncertain environments.