The Impact of Idiosyncratic Risk and Macroeconomic Uncertainty on Firms’ Leverage and Investment: Evidence from the Different Industries of Pakistan

Abstract

The main purpose of this study is to empirically examine the impact of idiosyncratic risk and macroeconomic uncertainty on firm leverage and investment. The analysis is carried out for a large panel data which is obtained from different industries of Pakistan comprising textile, auto and allied, cement, fuel and energy and sugar over the period of 2008-2018. Our investigation provides evidence that firm use less debt during periods of high risk. It also shows that as macroeconomic uncertainty and idiosyncratic risk increases, firms reduce their degrees of leverage. This study shows that idiosyncratic risk has an indirect and statistically significant effect on the Pakistan target firms’ leverage. However, highly profitable firms’ leverage is more sensitive to macroeconomic uncertainty and less sensitive to idiosyncratic risk. The result related to firm characteristics suggests that the firm specific variables such as firm size, tangibility, debt to asset ratio, growth of sales and cash flow to assets ratio are important in the determination of different firms’ investment. The finding also reveals that firm’s investment is more sensitive during periods of heightened firm idiosyncratic risk.  The outcome of the paper is useful for firms’ investment decision and authorities in designing of effective fiscal and monetary policies.