Uncertainty, Stock Prices, and Debt Structure: Evidence from the U.S.-China Trade War

Using the recent U.S.-China trade war as a laboratory, we show that policy uncertainty shocks have a significant impact on stock prices. This impact is less negative for firms that heavily rely on bank debt whereas non-bank debt does not have a mitigating effect. Moreover, the mitigating effect of bank debt is concentrated among zombie firms. A zombie firm that derives half of its capital from bank debt has no negative stock price reaction to increased uncertainty. These results are consistent with bank debt providing insurance for zombie firms in bad economic times. Our results are robust to controlling various firm-level characteristics that have been shown to affect the responsiveness of stock prices to macroeconomic shocks, including Tobin’s Q, firm size, balance sheet liquidity, along with firm and industry-date fixed effects. We further show that our results are not driven by changes in firms’ debt structure in anticipation of a trade war, using the firm-level debt structure before Donald Trump’s presidency as an instrument. Additionally, our results remain consistent when we restrict our sample to firms with a zero revenue share from China, suggesting that the revenue exposure to China does not explain our results. Our findings also cannot be explained by the differential usage of bank debt and non-bank debt between the zombie and non-zombie firms because the two groups’ utilization of both types of debt turn out to be similar. Finally, we show that our results are robust after creating matched samples of zombie and non-zombie firms based on their firm-level characteristics.