Khóa luận tốt nghiệp Tài chính ngân hàng: Geopolitical risk and capital structure decisions of US firms: An empirical study

LIST OF ABBREVIATIONSAbbreviations Full name Debt Ratio Capital structure EIDL Economic Injury Disaster Loans GDP Gross Domestic Product GEPU Global Economic Policy Uncertainty GICS Glob

UNIVERSITY OF ECONOMICS AND BUSINESS (UEB)

FACULTY OF FINANCE AND BANKING

000 An empirical study.

Teacher instruction : PhD Vu Quoc Hien

Student name : Trinh Thi Phuong Thao

Student code : 19050735

Class : QH-2019-E-TCNH-CLC2

Ha Noi - 2023

UNIVERSITY OF ECONOMICS AND BUSINESS (UEB)

FACULTY OF FINANCE AND BANKING

0o00—

GRADUATION THESIS

An empirical study.

Ha Noi - 2023

I hereby declare that this graduation thesis, entitled “Geopolitical risk and capital structuredecisions of US firms: An empirical study”, is my own original work, produced with the guidanceand support of our supervisor

Furthermore, I assert that all sources used in this thesis, whether they are primary data orsecondary information, have been clearly acknowledged and cited in the appropriate sections ofthe thesis I have not knowingly or intentionally included any information that is inaccurate,

misleading, or false Any opinions expressed in this thesis are solely my own and do not represent

the views of any other individual or organization

This statement is entirely our responsibility

Students

the topic so that we can understand and complete this research paper.

We would also like to express our sincere thanks to the teachers in the Faculty of Finance Banking in particular and all the teachers of the University of Economics - VNU in general forcreating learning conditions to help us improve our skills self-study ability to complete theresearch well

-Due to limited knowledge and reasoning ability, we cannot avoid certain shortcomings Welook forward to receiving the contributions of teachers to make this scientific research better

Thank you sincerely!

ii

TABLE OF CONTENTS.

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LIST OF ABBREVIATIONS

Abbreviations Full name

Debt Ratio Capital structure

EIDL Economic Injury Disaster Loans

GDP Gross Domestic Product

GEPU Global Economic Policy Uncertainty

GICS Global Industry Classification StandardGPR Geopolitical risk

GPRA Geopolitical risk act

GPRC Geopolitical risk country

GPRT Geopolitical risk threat

PPP Paycheck Protection Program

SEC Securities and Exchange Commission

US United State

LIST OF TABLES.

Table 4 1 SUMMATY 2y 20

Table 4 2 Correlation IẪATÌX - 5c c+ th HH HH HH HH Hà HH HH re giờ 22 Table 4 =0 7 24

Table 4 4 InteraCtÏOH «cà HH HH HH1 gờt 26 Table 4 5 Sector ClassifiCatÏOn -.«-+cs+rkekhtHEHH.HHH HH 111.111 1gre 29 Table 4 6 GPR and Capital structure by indUStTW -«cccsxeersrrrerrtrirrrrrrirrrrrirrrrrrrrrree 30 Table 4 uc 35

Table 4 0o 37

Table 4 9 Industrials 39

Table 4 10 Utilities ee 41

vi

Geopolitical risk refers to the potential instability in politics or society in a country or region

that could affect economic growth and investment opportunities, thus impacting business

decisions This study investigates the role of geopolitical risk (GPR) in financial leveragedecisions across 11 U.S economic sectors according to the Global Industry ClassificationStandards (GICS) The current thesis uses panel data methods and examines 4466 listedcompanies in the United States from 2003 to 2022The observation also shows thatcompanies in the healthcare, financial, industrial and utilities sectors are positivelycorrelated with GPR, while other sectors are not affected Furthermore, the correlated of GPR

on the debt ratio of heavily leveraged companies is more significant than other sectors Theseresults remain unchanged when controlling for relevant macroeconomic factors

Apart from examining the impact of geopolitical risk on financial leverage decisions, this

study also investigates how companies adjust their capital structure decisions to respond to

changes in GPR The findings of the research provide valuable insights into how geopoliticalrisk affects the financial decisions of U.S companies and can help investors and policy makers

to effectively manage these risks As such, this study is expected to have significantimplications for companies, investors, and policy makers in the United States and around theworld, especially in an increasingly uncertain and volatile geopolitical environment Overall,this research adds to our understanding of how geopolitical risk can affect businesses and

highlights the importance of managing these risks effectively

CHAPTER 1: INTRODUCTION

1.1 Research background

Geopolitical risk is defined as a risk related to war, terrorism, and tensions between countriesthat affect normalcy, peace, and international relations Recently, GPR has been considered asubstitute political risk criterion because it affects broadly However, it differs significantlyfrom other measures of geopolitical instability and macroeconomic risk At the micro level,

which is the focus of this study, geopolitical risk has become an increasingly important

consideration for businesses operating in the current interconnected global economy Thepotential for unexpected geopolitical events or international conflicts to disrupt supplychains, impact exchange rates, and create financial market uncertainty can have significantimplications for corporate capital structure decisions Unfavorable political situations candirectly affect a country's economic and commercial activities (Ari Aisen, 2013) Under theimpact of events such as terrorist attacks, civil wars, cyberattacks, trade and energy wars, oilsupply reductions, and war and conflict-induced migrations, along with economic sanctionsand geopolitical tensions, the level of political risk in a country can increase significantly.These events are often external shock factors that increase instability and have negativeimpacts on the economy (Julio, 2009) Companies exposed to higher levels of geopolitical risktend to have lower profits, indicating that political risk can affect the cost of equity financingand may affect corporate capital structure decisions (Bansal & KiKu, 2019) The uncertaintyabout political risk also increases the incentive to save for businesses and consumers Thisreduces investment and consumption, causing a delay in economic growth and increasingmarket risk As political uncertainty increases, companies tend to increase their cashholdings in their asset structure and reduce their use of debt to ensure liquidity and financialstability (Bloom, 2009) It is also noteworthy that economies that are more prone to politicalrisk are more fragile economically (Chiu, 2018) This can lead to decreased productivity,declining stock markets, increased interest rates, and even economic recession Therefore,understanding the factors that affect a company's financial decisions to cope with politicaluncertainty can help companies and investors better manage risks and navigate the complex

landscape of global politics and finance This can lead to decreased productivity, declining stock markets, increased interest rates, and even economic recession.

1.2 Define research objectives and tasks.

Political uncertainty, whether international or domestic, can cause chaos and conflict infinancial markets, negatively impacting the economy In addition, it also affects the financialbehavior of companies According to the (IMF, 2023) and (Narjess Boubakri, 2012), political

uncertainty often increases the cost of public debt financing and the cost of private borrowing

for companies Previous studies have shown that companies tend to use more cautiousfinancial strategies to reduce predicted political risks This information shows that political

uncertainty can have negative consequences for the economy and companies and needs to

be tightly managed to minimize its negative impact

The focus of this study is to explore the relationship between geopolitical risk and capitalstructure decisions of US companies, identifying factors that influence the sensitivity of thesedecisions to geopolitical risk Additionally, the study aims to evaluate the effectiveness ofdifferent strategies used by various industries in the US to manage geopolitical risk

The research task is to comprehensively evaluate existing literature on political risk and itsimpact on capital structure decisions of US companies Collect data on political risk indicesand financial variables of sample companies in the US Also evaluate the impact of politicalrisk on different components of capital structure, such as debt levels, equity issuance, etc.Test the effectiveness of specific firm-level factors, such as size, industry, and financialflexibility, in relation to the relationship between political risk and capital structuredecisions Draw conclusions and provide recommendations for US companies, if any, on how

to effectively manage political risk in their capital structure decisions

1.3 Research question

- Is geopolitical risk correlated to the capital structure of companies in the United States?

- Is there a significant difference in the correlation between US companies’ capital structureand geopolitical risk based on their industry, size, profitability, or liquid assets?

1.4 Research objectives and scope.

This study aims to analyze the correlation between geopolitical risk and the capital structure

of US companies I chose the US market because it is one of the largest and most developedeconomies in the world, and has a significant influence on the global economy For example,

a presidential election or a decision by the US government can affect the country's economic policy, trade policy, and investment policy.

In addition, the United States is also one of the countries with many foreign relations andstrategic military alliances around the world Political conflicts or adverse events may occur

in those countries and affect the economic, commercial, and investment relations of theUnited States with those countries This can also create risks for the US economy and theworld as a whole

1.5 Overview of data and research methods

Collect data on geopolitical risk indicators and financial variables of sample US companies

The sample will include companies from different sectors and scales to ensure that the

results are representative of the general population of US companies

The research methods will involve a combination of descriptive and quantitative analysis.Descriptive analysis will be used to examine trends and patterns in the data and to identifyany significant differences between different groups of companies Quantitative analysis will

be used to estimate the relationship between geopolitical risk and capital structure decisionswhile controlling for other factors that may influence financial decisions

1.6 Contribution of research

The contribution of this research is significant Recent literature has mainly focused onpolitical risks in certain industries of a few countries and their impact on domestic corporate

financial decisions This study is among the first to investigate the relationship between

international political risk and the decision to use capital structure of all the public

companies in the United States

The research on the role of geopolitical risk in the financial leverage decisions of US firmsmakes several significant contributions to the field offinance and economics First, the studyprovides empirical evidence of the impact of geopolitical risk on the capital structuredecisions of firms in different economic sectors in the US This knowledge is particularlyrelevant given the increasing geopolitical tensions and uncertainties in today's global

economy.

Second, the study reveals that the effects of geopolitical risk on financial leverage decisionsvary across different sectors Companies in the manufacturing and real estate industries, for

example, are found to decrease their financial leverage as geopolitical risk increases In

contrast, companies in the utilities industry tend to experience a positive impact on their

financial leverage under the same conditions These findings suggest that different sectors

may respond differently to geopolitical risks and that investors and policymakers must take

these sectoral differences into account

Third, the study highlights the importance of heavy leverage companies in the context ofgeopolitical risk Specifically, the research indicates that heavily leveraged companies aremore susceptible to the effects of geopolitical risk on their capital structure decisions thanother sectors This information is particularly relevant for investors and policymakers

interested in identifying vulnerable companies that are more exposed to geopolitical risk.

1.7 Structure of the study

Chapter 1: Introduction

Chapter 2: Literature review

Chapter 3: Methodology

Chapter 4: Empirical Results

Chapter 5: Conclusion and Recommendation

CHAPTER 2: LITERATURE REVIEW.

In this chapter, a comprehensive understanding of both theoretical and empirical literature

on capital structure and the macroeconomic and institutional factors affecting it is provided

By examining relevant literature, identifying key factors influencing capital structuredecisions, and providing a theoretical framework for the empirical analysis conducted insubsequent chapters

I delve into this chapter to explore the relationship between political risk and capitalstructure decisions By examining both empirical events and quantitative economictechniques used in previous studies, we can better understand how these two variablesinteract Additionally, my research aims to draw attention to potential avenues ofinvestigation to further explore this relationship

2.1 Theoretical basis

2.1.1 Theory of capital structure

s* Capital Structure Irrelevance Theory of Modigliani and Miller

The Modigliani and Miller (MM) Capital Structure Irrelevance Theory of (Modigliani, 1958)

is considered the basis of modern capital structure theory MM assumes that firm value is not

influenced by the capital structure, securities are traded in a perfect capital market,transaction, bankruptcy, and taxation costs do not exist, and all relevant information isavailable to insiders and outsiders Under these assumptions, MM proved that there is nooptimal debt to equity ratio, and capital structure is irrelevant to shareholders’ wealth Whilethe theory was theoretically sound, it was based on unrealistic assumptions, leading toextensive research on capital structure The presence of corporate taxes led MM toincorporate the effect of taxes on firm value and cost of capital, resulting in added benefits of

using debt capital, such as a lower capital cost While weaknesses exist in MM's theory, it

cannot be entirely ignored and has contributed to the development of several other capitalstructure theories

s* Trade off theory

The Trade-off theory is a capital structure theory that suggests that companies strive to

maintain an optimal capital structure that balances the benefits of debt (such as tax shields

and lower costs of capital) with the costs of debt (such as bankruptcy risk and higher interestrates) According to this theory, there is an optimal level of debt that a company shouldmaintain, beyond which the costs of debt outweigh the benefits As such, companies may usedebt financing to increase their returns to shareholders and minimize their cost of capital,

but they will avoid over-leveraging to the point where the risks of financial distress become

too high The Trade-off Theory also suggests that the optimal capital structure may varybetween industries and companies, depending on factors such as business risk, assettangibility, and growth prospects (Miller, 1958)

s* Pecking order theory

Pecking order theory is a capital structure theory that suggests that firms have a preferredhierarchy of financing sources According to this theory, companies will first use internalfinancing, such as retained earnings, to fund their investments If internal financing is notsufficient, firms will then turn to debt financing, starting with the least risky and cheapestsources of debt, such as bank loans, before considering more expensive and riskier sources,such as bonds Finally, as a last resort, companies will consider equity financing, as issuingnew shares can signal to investors that the company is undervalued The pecking ordertheory was first proposed by (Myers, 1984) and has since been widely researched andapplied in the corporate finance field

“+ Market Timing theory

Market Timing Theory suggests that a company's capital structure decisions are influenced

by their perception of the market's conditions and their ability to time these conditions to

their advantage This theory argues that firms adjust their financing choices to take

advantage of the market's favorable conditions to raise capital through equity offerings ordebt issuance For example, if a company perceives that the market conditions are favorablefor equity issuance, they will issue equity, and if the market is favorable for debt issuance,

they will issue debt The main assumption of this theory is that firms have superior information about the market's conditions, and they use this information to make financing

decisions that maximize their value However, the market timing theory has been criticized

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for assuming that firms can accurately predict market conditions, and for neglecting the cost

of issuing securities and the potential impact on shareholder value (Baker, 2002).

“* Credit Rating - Capital Structure (CR-CS) Hypothesis.

The Credit Rating - Capital Structure (CR-CS) Hypothesis suggests that credit rating agencies

play a crucial role in determining a firm's capital structure decisions According to this

hypothesis, firms with higher credit ratings have access to cheaper financing options, whichincentivizes them to maintain a lower debt-to-equity ratio On the other hand, firms withlower credit ratings face higher borrowing costs and may need to rely more heavily on equityfinancing As a result, these firms may be more willing to take on debt and maintain a higherdebt-to-equity ratio in order to offset their higher borrowing costs The CR-CS hypothesissuggests that credit ratings act as a signal to investors regarding a firm's creditworthiness,which influences their financing decisions and ultimately impacts the firm's capital structure

(Kisgen, 2006)

2.1.2 Factors affecting capital structure

Capital structure is a crucial aspect of corporate finance and refers to the mix of debt andequity that a company uses to finance its operations and growth The decision of how muchdebt and equity to use in a company's capital structure is influenced by various factors,including the company's size, growth prospects, profitability, risk, and industrycharacteristics One of the main factors affecting a company's capital structure is the cost ofcapital, which is the cost of financing through equity or debt Companies must strike a balancebetween the cost of capital and the risks associated with each type of financing Another

factor is the company's cash flow, which refers to the amount of cash generated by a

company's operations that can be used to service debt or pay dividends High levels of cashflow can allow a company to take on more debt, while low levels of cash flow may limit theamount of debt a company can take on Other factors that can affect a company's capitalstructure decisions include taxes, regulatory environments, macroeconomic conditions, andmarket conditions Ultimately, a company's optimal capital structure is a balance betweenthe costs and benefits of different financing options and depends on the specific

circumstances of the company and its industry.

Acompany's optimal capital structure is a balance between the costs and benefits of different financing options and depends on the specific circumstances of the company and its industry.

Achieving an optimal capital structure is crucial for companies as it can affect their financialperformance, ability to fund operations and growth, and ability to respond to unexpectedchallenges As such, it is critical for companies to carefully evaluate the different factors thatcan impact their capital structure decisions and make informed decisions that best serve

their long-term interests.

2.1.3 The significance of geopolitical risk.

Geopolitical risk refers to the risk of political and economic instability in a country or region

that can have significant impacts on the value of investments in that area This may include arange of factors such as political instability, armed conflict, changes in government policy,economic sanctions, and trade disputes Political risk can affect different sectors andindustries in different ways, and the impact can vary depending on the timing, severity, andscope of the risk Because political risk can have significant impacts on financial markets,businesses and investors often monitor these risks and incorporate them into their decision-making processes

Geopolitical risk can have significant impacts on the United States, both in terms of theeconomy and foreign policy The United States is a major player in global politics andeconomics and is thus often affected by political risks in different parts of the world Forexample, a military conflict in the Middle East could lead to disruptions in oil supply, whichcould have significant impacts on the U.S economy Similarly, economic sanctions againstcountries like China or Russia could lead to reduced trade and investment, which could affect

U.S companies operating in those countries In addition, trade disputes with other countries,

such as the ongoing trade tensions with China, could lead to tariffs and other trade barriersthat could impact U.S businesses and consumers

Geopolitical risks can also affect the foreign policy of the United States For example, a majormilitary conflict can lead to the U.S involvement in a costly and prolonged conflict, with

significant implications for both foreign policy goals and the domestic political environment

Overall, the impact of geopolitical risks on the United States depends on the nature andseverity of the risks, as well as the U.S response to them As a large global power, the UnitedStates must be vigilant and proactive in managing political risks and developing strategies tominimize their impact on the economy and foreign policy

2.1.4 Other macro risks (GDP, Inflation)

s* GDP

Gross Domestic Product (GDP) brings about some risks that may affect the economy of acountry One of the major risks is unemployment and economic recession A significant

decrease in GDP can lead to reduced spending by businesses and consumers, leading to

unemployment and economic recession Another risk is inequality in wealth distribution.Although GDP may increase, the benefits may not be distributed evenly, leading to economicdisparity between the rich and the poor GDP can also have negative impacts on theenvironment The development of the economy can lead to increased pollution and depletion

of natural resources, resulting in environmental degradation Finally, GDP also posesfinancial risks, such as the decline of the stock market, rising interest rates, and increasingbad debt in banks These risks can cause instability in the economy and lead to economic

recession Despite these risks, GDP is still an important indicator for measuring the economic

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development of a country and plays an important role in the investment and business

strategies of companies (Simon Kuznets, 1941).

s* Inflation.

Inflation is a sustained increase in the general price level of goods and services in aneconomy It carries with it some risks that can affect the economy and those who live in it.One significant risk of inflation is a decrease in the purchasing power of money As prices ofgoods and services rise, the value of money decreases, leading to a decrease in purchasingpower This, in turn, can lead to reduced consumer spending and slower economic growth.Another risk is an increase in interest rates When inflation rises, central banks may increaseinterest rates to control it, which can lead to reduced borrowing and spending by businessesand consumers Inflation can also lead to uncertainty in the economy, making it difficult forbusinesses to make investment decisions and plan for the future Moreover, inflation canhave negative impacts on those with fixed incomes, such as retirees, as the purchasing power

of their savings decreases Despite the risks, a moderate level of inflation is necessary foreconomic growth and stability However, high levels of inflation can pose significant risks tothe economy and those who live in it Therefore, it is important to manage inflation to ensure

a stable economy and a high standard of living for people (Mishkin, 2016 )

2.2 Overview of foreign documents

In previous studies, most of them pointed to the influence of GPR on one industry or many

different countries, but no study really showed the correlation between GPR and financial

leverage of companies United States Therefore, there is a need for comprehensive studies

on this issue

Geopolitical risk has been a long-term issue in political history, but it was not until the 9/11crisis that researchers began to investigate the impact of terrorist events on economic

conditions According to (Kallandranis, 2015), terrorist activities can lead to a decrease in

investment, income, and consumption, resulting in an economic contraction For example,

(Kunreuther, 2003) estimated that the 9/11 attack resulted in the US economy losingbetween 80 to 90 billion dollars However, the impact of terrorism is not limited to the US.(Eckstein, 2004) showed that if Israel had not been subjected to terrorism in the 2000s, its

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per capita output would have been 10% higher by 2004 Similarly, (Abadie, 2003) studiedthe economic costs of the Basque region's conflict resulting from terrorist actions in the late1960s On the other hand, some articles suggest that policy uncertainty can increaseeconomic growth by reducing private investment and increasing spending on publicinvestment (Bloom, 2009), (Epstein, 1989),

2.2.1 The negative impact of GPR e on the capital structure

Political uncertainty and global political risk (GPR) are two factors that have received a lot of

attention in documents regarding the financial decisions of companies, especially in the field

of capital structure decisions Many studies have examined the relationship between thesefactors and the financial activities of companies, such as debt financing, equity financing, andinitial public offerings (IPOs) A common proxy for political uncertainty in the literature iselections or changes in government officials For example, (Colak, 2017) found that thenumber of IPOs decreased in a specific country in the United States during a period ofexecutive elections compared to a non-election period They also suggested that higherpolitical risk leads to an increase in capital costs

Terrorism is another proxy for political uncertainty that has been explored in the literature.For instance, (Lubo§ Pastor, 2013)found that companies with higher exposure to terrorismare more likely to issue equity, while those with lower exposure are more likely to issue debt.Moreover, uncertainty indices have also been used for political uncertainty A study by (Xu,

2016) used the Global Economic Policy Uncertainty (GEPU) index to investigate the impact

of political uncertainty on the capital structure of Chinese firms They found that higher GEPUled to a decrease in debt financing, while the impact on equity financing was insignificant

In addition to political uncertainty, GPR has also been examined in relation to corporatefinancial decision-making (Chiu, 2018) found that GPR has a significantly negative impact onthe stock returns of companies in emerging markets Another study by (Chung-Hua Shen,2015) investigated the impact of GPR on the debt maturity structure of Chinese firms They

found that higher GPR led to shorter debt maturities, which may be a strategy to reduce risks

related to political instability

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In general, the literature shows that political uncertainty and government policy risk havesignificant implications for the financial decisions of companies, especially those related totheir capital structure Understanding the impact of these factors is crucial for companies,andinvestors, as it can help them make informed decisions in an uncertain and volatile

environment.

Based on the synthesis of studies, it can be concluded that political uncertainty is increasingand causing conflicts in the market, affecting the behavior of companies However, previous

studies have focused on political uncertainty within a specific country, while research on

international political conflicts and their impact on financial decisions of companies is stilllimited For example, in the study by (Guangli Zhang, 2015), the authors used the example ofthe 18th National Congress of the Communist Party of China in 2012 At that time, the Chinese

stock market experienced an unstable period due to investor concerns about the economic

and financial reform plans of the Chinese government This study showed that politicaluncertainty led to an increase in market risks and reduced the ability of companies to seekexternal financial sources, leading to a preference for internal financial sources The study by(Xiao-Ming Li, 2021) also demonstrated that companies face more sensitive financial

constraints from the impact of economic policy uncertainty on their financial decisions.

2.2.2 The positive impact of GPR e on the capital structure

Based on foreign studies, there is evidence that geopolitical risk can have a positive impact

on the capital structure decisions of firms For example, a study conducted by (Girma, 2019)

found that firms operating in politically unstable countries tend to have a higher equity ratio than those in more stable countries The authors suggest that this may be due tothe fact that firms in politically unstable countries may face higher borrowing costs andgreater difficulty accessing equity markets, making debt financing a more attractive option.Another study by (Ainsley Granville Andre Jorge Bernard, 2021) on Indian firms found that

debt-to-geopolitical risk has a positive impact on the use of long-term debt The authors suggest that

this may be due to the fact that long-term debt allows firms to lock in lower interest rates,providing a hedge against potential increases in borrowing costs due to geopoliticalinstability these studies suggest that firms may choose to increase their debt-to-equity ratio

or use debt financing as a way to mitigate the risks associated with geopolitical instability

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However, it is important to note that the specific effects of geopolitical risk on capital

structure decisions may vary depending on the industry, country, and other contextual

factors

According to (Li, 2017) the author examined the relationship between economic policyuncertainty and equity premium The main idea of Xiaoming Li's study on economic policyuncertainty and equity premium is to examine the impact of economic policy uncertainty onthe equity premium in the United States The study aimed to provide new evidence andinsights into the relationship between economic policy uncertainty and equity premium,

which is the excess return that investors demand to hold stocks over a risk-free asset The

study utilized a dynamic panel model and analyzed data from the US stock market to examinethe effects of economic policy uncertainty on the equity premium The results showed that

economic policy uncertainty has a significant and positive impact on the equity premium,

indicating that higher levels of uncertainty about economic policy can lead to higher equity

premiums.

2.3 Research gap

Despite current research examining the impact of various macroeconomic factors andspecific firm characteristics on capital structure decisions, there is a lack of researchspecifically focusing on the relationship between political risk and capital structure decisions

of US firms Therefore, there is a research gap in understanding how political risk affects thefinancial decisions of companies in the US, especially in the context of increasing globalpolitical uncertainty By addressing this gap, this study can provide profound insights intothe risks and potential opportunities associated with different capital structure decisionswhen faced with political uncertainty Previous studies also often focus on a specific industry

or country without comparing different industries Therefore, this study also explores howfactors such as scale, profitability, and leverage impact capital structure decisions in thecurrent political context, as well as the differences in capital structure decisions of US firms

based on their degree of internationalization and exposure to political risk.

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2.4 Chapter summary.

Chapter two begins with an overview of the concept of political risk and its impact oncompanies It then delves into theories of capital structure and how different economicconditions can affect capital structure choices The literature review identifies a research gap

in the impact of political risk on capital structure decisions of US companies, which current

research aims to address The chapter also examines related studies that have explored therelationship between political risk and capital structure decisions in other countries

Additionally, this chapter highlights key findings from the evaluated literature, including thenegative impact of political risk on the use of debt financing, the influence of macroeconomicfactors such as GDP growth and inflation on capital structure decisions, and the impact ofspecific company characteristics such as size, profitability, and tangibility on capital structuredecisions The chapter concludes by identifying the research gap in the literature on theimpact of political risk on capital structure decisions of US companies and the need forfurther research in this area

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CHAPTER 3: RESEARCH METHODOLOGY

3.1 Research Methods

To examine the impact of geopolitical risk on a company's capital structure, I reviewedrelevant studies and developed a regression model based on the literature of (Paolo Fiorillo,2023), (Drobetz, 2012), and (Suntichai Kotcharin, 2020) The study used various

econometric techniques, such as fixed effects regression estimation, to analyze the

relationship between GPR and financial leverage decisions The study also controlled forrelevant macroeconomic factors, such as interest rates, inflation, and GDP growth, to isolatethe effect of GPR on capital structure decisions Overall, the research methods employed inthis study were robust and allowed for a comprehensive analysis of the impact of GPR oncapital structure decisions of US firms To measure the relationship between political riskand the decision to use a certain capital structure, I estimated the following fixed-effectsmodel:

CAP; p= @ + Bị Ln(GPR), + 62Controls;, + @¡ + Tự + Ei¢

In addition, to clarify whether the heightened geopolitical risk is affected by other factors, theauthor further tests the following model:

Debt Ratio = GPR+GPR*Lag Debt Ratio + GPR*Ln(Sizes)+ GPR* ROA

+ GPR* Liquid Assets +GPR*Inflation+GPR*GDP

In the research model, I use the main independent variable as GPR, representing the natural

logarithm of GPR, GPRT, GPRA, and GPRC_USA indices, respectively To distinguish the impact

of each index on capital structure, I do not include them in a simultaneous equation due tomulticollinearity issues Additionally, I use the lag of all GPR indices, taken from previous

studies (Dejuan & Ghirelli, 2018) The GPR index is updated monthly, while my financial data

is annual, so I calculate the ratios based on annual averages The dependent variable in the

study is capital structure, defined as leverage by the debt-to-total asset ratio Controlvariables in the model include Net margin, ROA, Sizes, Sales, Liquid Assets Moreover,economic variables such as the US GDP and Inflation rate are included as control variables toassess their impact Finally, I add time and industry dummies to control for fluctuations based

on them In addition, Variable Debt Ratio represents the debt ratio in the past The inclusion

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of Variable Debt Ratio, which represents the debt ratio in the past, allows to investigate

whether companies tend to maintain a stable debt ratio over time or whether they adjust

their capital structure in response to changes in green performance The dataset also includesGPR indexes specifically designed for advanced and emerging economies

3.2 Data.

3.2.1 Geopolitical risk index

Dario Caldara and Matteo Iacoviello developed a new index for adverse political events based

on counting the number of articles on political tensions and studying the economicdevelopment and impact of it since 1900 The geopolitical risk index (GPR) spikes abruptlyaround the two world wars, at the onset of the Korean War, during the Cuban missile crisis,and after the September 11 attacks

Caldara and Jacoviello's GPR index reflect the results of an automated text search of theElectronic Archives of 10 newspapers: The Chicago Tribune, The Daily Telegraph, FinancialTimes, The Globe and Mail, The Guardian, The Los Angeles Times, New York Times, USAToday, The Wall Street Journal, and The Washington Post They compute the index bycounting the number of articles related to adverse political events in each newspaper for eachmonth (as a percentage of the total number of articles)

The search was organized into eight categories: threat of war (type 1), threat to peace (type

2), military buildup (type 3), threat of nuclear weapons (type 4), threat of terrorism (type 5),

outbreak of war (type 6), escalation of war (type 7), and terrorist actions (type 8) Based onthese search categories, Caldara and Jacoviello also developed two sub-indices The politicalthreat index (GPRT) includes words from types 1 to 5 The political action index (GPRA)

includes words from types 6 to 8 The benchmark index (GPR) uses 10 newspapers and starts

in 1985 The method for constructing the historical political risk index (GPRH) uses threenewspapers and starts in 1900 The GPR index for each country is based on an automatedtext-search of electronic archives of three prominent U.S newspapers: The New York Times,Chicago Tribune, and The Washington Post Caldara and Iacoviello calculate the country-specific index by analyzing the monthly share of all articles from 1900 that meet the criteria

for inclusion in the GPR index and mention the country or its major cities This index is

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expressed as a monthly share of newspaper articles, and it provides insight into the U.S.

perspective on risks associated with or involving that particular country.

3.2.2 Variables description

In addition to GPR data, specialized indices for US companies were collected from Refinitive

The sample includes 6,400 active and inactive US companies Geographic Political Risk (GPR)

data was taken from its website The initial sample had to comply with some samplingparameters Companies were included or excluded from the sample based on the following

factors: (a) companies with missing data were not included in the sample; (b) Eliminate debt

coefficients with a value greater than 1; (c) Only keep ROA in the range of 1-99 After

processing the data, we have an unbalanced data set of 4466 companies representing 64,749observations per year Since listed companies have different initial public offering (IPO)periods, we use the unbalanced panel regression method to test it is common practice infinancial research to include control variables to isolate the effect of the independent variable

of interest on the dependent variable In this case, the independent variable of interest is GPR,

and the dependent variable is the capital structure of the firm The control variables used inthis analysis, such as ROA, firm size, liquid asset, and net margin, are commonly used in

financial research to control for other factors that may affect the dependent variable

Therefore, their inclusion in this analysis is consistent with the general practice in financialresearch Macroeconomic variables from various sources are also converging They include

US GDP growth, inflation index Details of all variables are presented in Table 3.1

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Table 3 1 Define Variables.

Natural Logarithm of the 12-month moving

average of Global Political Risk Threat (GPRT)Index

Natural Logarithm of the 12-month movingaverage of Global Political Risk Act (GPRA)Index

Natural Logarithm of the 12-month movingaverage of Global Political Risk Country(GPRC) Index

Consumer Price Index

Domestic Consumption Growth Rate

Net Profit after Tax-to-Total Assets

Net Revenue after Tax-to-Net Profit Ratio

Natural Logarithm of Total Assets

Natural Logarithm of Net Profit

Liquid Assets-to-Total Assets

Source

Refinitive

Caldara, Dario, andMatteo Iacoviello(2021)

Caldara, Dario, and

Matteo Iacoviello(2021)

Caldara, Dario, andMatteo lacoviello(2021)

Caldara, Dario, andMatteo Iacoviello(2021)

This section provides a summary of the descriptive and estimation statistical models used toanalyze the relationship between GPR and capital structure choices of US listed companies.The research findings demonstrate a significant correlation between GPR and capitalstructure decisions Moreover, the section also compares the results across different

industries to better understand how the decision-making behavior of US listed companies is

influenced by GPR By analyzing data across industries, researcher can gain a deeper

CHAPTER 4: RESULTS AND DISCUSSION

understanding of the factors that influence capital structure choices

0.230.30

2.36 2.710.24

0.01

0.04

Min0.00

4.284.31

3.80

0.47-84221.66

0.00

-2.79-6.91

-10.2-0.00

-0.02

-.0.05

Max1.00

14.34 13.66 1.000.03

0.11

Source: Author synthesis

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Table 4.1 in the research provides useful information regarding the debt-to-total-asset ratio

and the gross property, plant, and equipment (GPR) investment of the sample companies.

The mean debt-to-total-asset ratio of 0.25 indicates that companies tend to finance theiroperations with a mix of equity and debt This suggests that companies are seeking a balancebetween the benefits of debt, such as tax shields and lower cost of capital, and the risksassociated with it, such as financial distress and reduced profitability However, the high

standard deviation of 0.23 indicates that there is significant variation in the debt ratios

among the sample companies This variation can be attributed to factors such as industry,company size, and growth potential, among others On the other hand, the high mean GPRCvalue of 0.08 suggests that the sample companies are actively investing in growth

opportunities The companies are likely to be investing in new technology, machinery, and

equipment to increase productivity and efficiency, and expand their operations However,the significant variation in the GPR investment among the companies suggests that not allcompanies are equally focused on growth Some companies may prioritize short-termprofitability over long-term growth, while others may have limited resources to invest ingrowth opportunities

The wide range of values for inflation and GDP suggests that the sample companies areexposed to a diverse set of macroeconomic conditions This variability in economicconditions could influence the companies’ capital structure choices and their response to

GPR The negative means of net margin and ROA suggest that, on average, the sample

companies are not experiencing strong profitability However, the significant variability inprofitability among the sample companies indicates that some companies are performingbetter than others Finally, the high mean values of Ln (Sizes) and Ln (Sales) suggest that thesample companies are relatively large and have high sales This could indicate that the samplecompanies are mature and established, which may influence their capital structure choicesand response to GPR

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