Balancing the books: The role of energy-related uncertainty in corporate leverage

Abstract

This study explores the influence of energy-related uncertainty (EUI) on corporate leverage. Using a novel and comprehensive uncertainty index regarding energy sectors, we find compelling evidence that firms adopt conservative financing strategies during uncertainty times as both book- and market-leverage decreases in response to heightened EUI. We determine that the elevated cost of borrowing driven by EUI is a possible mechanism deterring firms from debt financing, thereby reducing corporate leverage. Furthermore, the impact of EUI is notably pronounced for short-term leverage as opposed to long-term leverage. Cross-sectionally, we observe that the negative connection between EUI and corporate leverage is mitigated by state ownership, indicating that firms are more willing to take on debt with government backing. Furthermore, our results withstand a series of robustness checks, affirming the credibility of our findings. Overall, our study holds extensive implications for companies, stakeholders, and policymakers due to the prevailing yet impactful nature of energy uncertainty.