Quality & Quantity (2024) 58:2677–2707

https://doi.org/10.1007/s11135-023-01768-8

Economic policy uncertainty, corporate diversification

and firm value: the global evidence

Zahid Jumah1 · Nabeel Safdar1 · Zahid Irshad Younas2 · Adeel Ahmed1

Accepted: 29 September 2023 / Published online: 6 November 2023

© The Author(s), under exclusive licence to Springer Nature B.V. 2023

Abstract
This paper investigates the impact of economic policy uncertainty (EPU) on firm value
and examines corporate diversification’s role between EPU and firm value. We employ
firm-level data for twenty-two countries from 2000 through 2020, which covers 364,433
firm-year observations of 29,709 unique firms and use index-based measures for EPU and
corporate diversification. The results illustrate that EPU negatively impacts the firm value.
However, corporate diversification positively moderates the adverse impact of EPU on the
firm value by efficiently mitigating the effect of financial constraints. Further, the addi-
tional analysis shows that related and unrelated corporate diversification can be instrumen-
tal in alleviating the negative impact of high EPU on firm value in developed economies.
In emerging economies, only unrelated diversification effectively deals with high EPU. The
results are robust to subsampling, sensitivity, and endogeneity issues. Our study suggests a
potential policy recommendation from a managerial perspective, that diversification helps
to sustain the firm’s value during uncertainty. Furthermore, Policymakers should recognize
high policy uncertainty as a threat to business environment stability and take measures to
reduce uncertainty and provide a more favorable environment for businesses.

Keywords Corporate diversification · Economic policy uncertainty · Firm value

JEL Classification L25 · G38 · G32

* Zahid Jumah
[email protected]; [email protected]
Nabeel Safdar
[email protected]
Zahid Irshad Younas
[email protected]
Adeel Ahmed
[email protected]
1
NUST Business School, National University of Sciences and Technology (NUST), H‑12 Sector,
Islamabad, Pakistan
2
Berlin School of Business and Innovation, Potsdamer Street, 180‑182 Berlin, Germany

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2678 Z. Jumah et al.

1 Introduction

Since the seminal book by Galbraith (1977), “The Age of Uncertainty,”, several events
reported by academia and media underlined uncertainty as a substantial issue in the cor-
porate environment. One cannot deny the existence of uncertainty in the business world.
However, there is no unanimous definition of uncertainty. Uncertainty regarding the geopo-
litical climate, industry-relevant events, firm-level news such as uncertain sales forecasts,
the rumors of a change in management or Chief Executive Officer (CEO) departure are a
few examples of uncertainty. Therefore, in the views of some scholars, uncertainty reflects
unpredictability in monetary, regulatory, and fiscal policies, which eventually exacerbate
market volatility (Abel 1983).
Recently, scholars have provided enormous attention to the impact of economic policy
uncertainty (hereafter, EPU) on various country-specific and firm-specific factors. Baker
et al. (2016) noted that after the global financial crunch of 2007–2008, government policy
uncertainty rose due to household and business uncertainty concerning the future govern-
ment regulatory environment, monetary policies, taxes, and spending. These authors argue
that EPU delays recovery after recessions as business organizations and households delay
their decisions concerning investment and consumption expenditures. Several factors are
found to be associated with uncertainty. Certain events influence the uncertainty in both
long- and short-time horizons. For instance, the fluctuation in oil prices has a short-term
effect on economic uncertainty. In contrast, other factors, such as currency volatility and
sudden changes in corporate leadership, may have a long-term impact Al-Thaqeb and
Algharabali (2019). Prior literature has used the implied volatility index (VIX) initially
constructed by the "Chicago Board Options Exchange," the oldest and most widely used
proxy of uncertainty. However, one major limitation of this proxy is that it captures only
market-relevant uncertainties. Another measure, news implied volatility (NVIX), was pro-
posed by (Manela and Moreira 2017) to gauge uncertainty. NVIX is constructed using text
data collected from the Wall Street Journal. Considering the significant effect of policy
uncertainty on various business decisions, Baker et al. (2016) developed an index encom-
passing the proxies of uncertainties suggested in the prior research, which they named the
BBD index, also referred to as the EPU index. The EPU index captures economic, news-
based, market, and government policy uncertainty factors. This index accurately captures
events primarily linked to higher policy uncertainties, with election periods, wars, the cri-
sis of the Eurozone, and the debt ceiling debates. Moreover, the index is also highly associ-
ated with VIX. The correlation of the EPU index with these events suggests that the EPU
index captures a broad range of economic, political, and legislative events that can influ-
ence macro and micro levels.
Since the initial work of Baker et al. (2016), academic scholars have started an interest
in investigating the role of EPU in a wide range of corporate activities, including financing
and investment decisions. For instance, Hong and Quang (2022) identified that when EPU
rises, firms likely to reduce their involvement in innovation activities. In addition, to its
influence on firm-specific decisions, empirical studies show that EPU negatively impacts
the financial markets and the real economy (Kelly et al. 2016; Pástor and Veronesi 2012).
Yung and Root (2019) explore the link between EPU and earnings manipulation in the
global context. Their empirical investigations reveal overwhelming findings that when EPU
increases (decreases), the earnings management practices of a firm increase (reduce). Inter-
estingly, additional evidence shows that the impact of EPU on earnings management is not
affected by the country-specific institutional characteristics and national culture. Moreover,

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using a Chinese companies sample, Ahsan et al. (2022a) portray that EPU hurts sustainable
development growth, particularly in companies with weak defensive business strategies.
Ilyas et al. (2022) investigate whether U.S. companies respond to EPU by changing their
CSR practices. Their evidence suggests that U.S. companies respond to high policy uncer-
tainty by enhancing their CSR investment, which are aligned with the risk management
perspective. However, the positive changes in CSR investment were found to be more pro-
nounced in larger firms. Further, economic uncertainty plays a critical role in determining
the firm’s operating environment and stimulates companies to take rapid strategic measures
(Hoang et al. 2021; Kang and Ratti 2015). In this connection, empirical studies show that
the consequences of high EPU stretch from the deferment of corporate investment (Ber-
nanke 1983; Gulen and Ion 2016; Ilyas et al. 2021; Julio and Yook 2016; Kang et al. 2014),
increase in corporate debt (Jumah et al. 2023), decrease in stock return (Liao et al. 2021),
soaring financial constraints and financing cost, and decreasing return on asset (Brogaard
and Detzel 2015; Pástor and Veronesi 2013; Phan et al. 2018).
Despite the enormous evidence around the impact of EPU on various micro and macro
facets, the economic effects of increased EPU on firm value are still under investigation.
Earlier empirical literature shows that high EPU decreases firm performance (Feng et al.
2021; García-Gómez et al. 2021; Iqbal et al. 2020). Whereas during high EPU, tightening
trade credit increases corporate value up to a certain level, and after that, it decreases value
due to trailing customers (Jory et al. 2020). However, the sustainability disclosure, the
role of national culture, corporate research and development, and investment in corporate
social responsibility activities moderate the negative effect of EPU on firm value (Ahsan
et al. 2022b; Ahsan and Qureshi 2021; Bsorghesi and Chang 2020; Li et al. 2017; Rjiba
et al. 2020). More essentially, there is still scant evidence in the literature that explores the
efficient mechanism that corporates can opt to decrease the adverse impact of economic
shocks that are exogenous to their state of operation. Therefore, delving into the connection
between EPU and firm value through corporate diversification represents a distinctive and
original contribution to the current body of literature.
This study employs a dataset comprising 364,433 firm-year observations of 29,709
firms operating in twenty-two countries from 2000 to 2020. The primary objective of this
research is to explore the influence of EPU on firm value and to examine the moderating
role of corporate diversification between EPU and firm value relationships. The empiri-
cal findings suggest that EPU negatively impacts firm value. However, corporate diversi-
fication positively moderates the adverse impact of high EPU on firm value by efficiently
alleviating financial constraints. Furthermore, the study reveals that related and unrelated
corporate diversification can be instrumental in developed economies for mitigating the
negative impact of high EPU on firm value. In contrast, in emerging economies, only unre-
lated diversification is effective. Also, we evaluate the reliability of our findings using
numerous robustness checks, including subsampling, sensitivity, and potential endogeneity
concerns.
This study significantly contributes to the current literature in several ways. First, we
show novel evidence by highlighting the strategic importance of corporate diversification
in mitigating the negative impact of EPU on firm value. Thus, it suggests a plausible pol-
icy recommendation from a managerial perspective that diversification helps to sustain the
firm’s value during uncertainty. Second, based on the large sample of twenty-two coun-
tries, our study supports the real options theory hypothesis that EPU decreases firm value
due to delaying investment and information asymmetry. Therefore, policymakers should
consider high uncertainty a threat to business environment stability. Third, our study aug-
ments the literature focusing on corporate diversification’s role in mitigating financial

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2680 Z. Jumah et al.

constraints (Aivazian et al. 2019; Jumah et al. 2022; Singhal and Zhu 2013) and identifies
financial constraints as a channeling factor in the relationship between diversification and
firm value, deepening the understanding of the underlying mechanisms.
The remaining paper is organized as follows. Section 2 consists of the literature review.
Section 3 includes the research design, including data, sample, variable, and model. Sec-
tion 4 illustrates the results. Section 5 discussion of results followed by Section 6 of con-
clusion of the study.

2 Literature review

2.1 EPU and firm value

There is widespread empirical research on the effects of EPU on firm-specific decisions,

valuation, and performance outcomes. Feng et al. (2021) explored the impact of EPU
on firm performance using the news-based measure of EPU. The aggregate results show
that high EPU adversely affects firm investment, revenue, and employment; however, the
negative effect is less in companies that are state-owned. In a similar work, Iqbal et al.
(2021) studied the nexus between EPU and performance by employing U.S. non-financial
firms’ data. For capturing the effect of EPU on firm performance, they use several prox-
ies such as returns on assets (ROA), returns on equity (ROE), Tobin’s Q, and Net Profit
Margin. After estimating the data with system GMM, in all proxies, the effect of EPU
on firm performance was shown to be negatively significant. García-Gómez et al. (2021)
investigate the EPU-performance relationship for 296 US tourism firms and found con-
sistent evidence with the previous two studies. Collectively, the recent literature on EPU
agrees with the view that high EPU adversely affects overall firm performance, and the
management should forecast the negative consequences of high EPU. Besides accounting
and market performance, EPU also influences other firm-level performance determinants.
For instance, it influences corporate precautionary saving motives, resulting in an increase
in cash holdings. Noticeably, the propensity for cash holdings is higher in firms that face
difficulties accessing external financing (Li 2019). Since EPU adversely affects aggregate
performance and enhances firms’ propensity to increase cash holding as a precautionary
measure, this may also affect their investment decisions. The reason is, hoarding more liq-
uid assets (e.g., cash) may negatively affect corporate investment decisions. In this respect,
the recent stream of research also takes an interest in examination of EPU influences on
corporate investment decisions (Chen et al. 2019; Ilyas et al. 2021; C. Kang et al. 2015;
Wang et al. 2014). The negative effect of EPU on investment also scraps firm growth and
value. A recent empirical study by Olalere and Mukuddem-Petersen (2022) examines
the direct nexus between EPU and firm value for a sample of 105 banks from countries
including Brazil, Russia, India, China and South Africa (BRICS). Using the "panel vector
autoregressive" and GMM specifications, they show a consistent negative EPU-FV rela-
tionship. However, regardless of the variation across countries concerning business and
economic conditions and geographical location, the negative effect remains consistent
across countries.
One of the key drivers behind the expected negative link between EPU and firm value
is a higher cost of financing. Liu and Zhang (2015) show that companies maintain a lower
level of capital structure in times of higher policy uncertainty because EPU deteriorates the
external financing environment, which stimulates firms to adjust their capital structure in

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response to high EPU. Moreover, the fluctuations in capital markets caused by EPU may
increase the premium demanded by the investors on the purchase of securities, thereby
increasing the cost of financing for companies. These increased costs of funds lead manag-
ers to put restrictions on investment. Higher costs of financing due to policy uncertainty
may also boost a firm propensity to save cash since the firms’ motive for the precautionary
saving increase during uncertainty time. Earlier studies based on U.S. firms data shows that
most firms increased their cash holdings during EPU rather than investing in valuable pro-
jects (Demir and Ersan 2017; Phan et al. 2019). Hence, by curtailing firm investment due
to higher borrowing costs, EPU would further decline future firm cash flows level. In addi-
tion, the literature demonstrates that increases in the cost of borrowing compel manage-
ment to restrict investment and lead them to invest in less risky investments (Vural-Yavaş,
2020) since EPU makes managers adopt more risk-averse policies (Chatjuthamard et al.
2020). Collectively, the shift towards risk-averse investment decisions because of high EPU
may put more added pressure on corporate cash flow level and variability, which may lead
to a decline in firm value (Vural-Yavaş, 2020). Moreover, high uncertainty elevates the
information asymmetry between borrowers and lenders. Consequently, the cost of capital
rises because of high default risk, adversely impacting the firm performance (Iqbal et al.
2020; Liu and Zhang 2015; Mirza and Ahsan 2020). Thus, we formulate the following
hypothesis.
On the theoretical ground, the theory of investment irreversibility states that uncertainty
in economic policies decreases firm investment due to precautionary delays (Bernanke
1983; Gulen and Ion 2016; Pindyck 1988; Wang et al. 2014). The decreasing effect of EPU
on investment also shreds firm growth and, ultimately, the firm value. In addition, high
uncertainty elevates the information asymmetry between borrowers and lenders. Thus, the
cost of capital rises because of high default risk and adversely impacts the firm perfor-
mance (Iqbal et al. 2020; Mirza and Ahsan 2020; Zhang et al. 2015). Moreover, infor-
mation asymmetry-induced financial constraints negatively affect the firm performance as
survey results stated by (Campello et al. 2010) show that 85% of the financially constrained
firm’s Chief financial officers (CFOs) reveal that they were contrived to renounce profit-
able investments. Thus, we develop our first hypothesis that during high EPU, the firm
value decreases.

H1 There is a negative association between EPU and firm value.

2.2 Moderating channels behind the EPU‑Firm value relationship

There are numerous studies on how firms protect their value during spike periods of
uncertainty. Prior literature suggests various mechanisms that can moderate the effect of
EPU and can be used as a safeguard against the adverse effects of high uncertainty. In this
respect, Jory et al. (2020) examine the role of effective trade credit policies in alleviat-
ing the adverse effects of EPU. Employing data from U.S. public companies, their find-
ings reveal that during high uncertainty conditions, firms minimize their receivable days
and reduce payable days from their suppliers. Thus, tightening the credit extensions results
in an increase in firm value. However, adopting such policies without policy uncertainty
results in a reduction in firm value, suggesting that such policies are only fruitful in high
uncertainty conditions. A similar study was conducted by Vo et al. (2022) using a Korean
firms sample. They demonstrated that high EPU leads firms to restrict trade credit. Fur-
ther investigations show that curtailing trade credit positively affects firm value. Mishra

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2682 Z. Jumah et al.

et al. (2022) assess whether EPU influences shareholders’ wealth and whether various
firms’ strategies (e.g., operations, marketing, and R&D capabilities) moderate the effect
of EPU. Initial results show that EPU decreases firm value (e.g., stock returns and Tobin’s
Q). However, higher marketing capability is shown to attenuate the decline in firm value.
Rjiba et al. (2020) show that CSR helps firms build social capital, which alleviates the
adverse effect of EPU. Likewise, Borghesi and Chang (2020) show that companies belong
to high intangible-intensity sectors, and those with R&D expenditures are more likely to
suffer from restrictive government policies during higher economic downturns. However,
these companies get substantial benefits from their socially responsible activities during
volatile economic conditions. Additionally, firms with more sustainable policies are more
likely to maintain their performance during policy uncertainty (Ahsan and Qureshi 2021).
Altogether, these studies consider CSR as an effective channel that can dampen the EPU’s
negative effect.1

2.2.1 The role of corporate diversification

Corporate diversification is found to have a crucial role in influencing various firm-level

decisions and outcomes. From the synthesis of past literature, it is documented that diversi-
fication can be defined and conceptualized in several ways. According to Lévy et al. (1964)
diversification can be defined as “the heterogeneity of output based on the number of mar-
kets served by that output”. Based on this definition, two products will represent a separate
market if their cross elasticity of demand is lower (the extent to which a change in the
price of one product affects the demand for another product), and in short-term, resources
needed during production for a product cannot transfer another product. Berry (2015)
defined diversification as the extent to which a firm actively operates in multiple industries.
In the view of Kamien and Schwartz (1975), diversification is defined as when a firm that
is classified in one industry produces products that also can fit in other industries. Unlike
the previous two definitions, Pitts and Hopkins (1982) define diversification in the context
of business rather than the industry, as firms are considered involved in more diversifica-
tion if they operate in multiple businesses simultaneously.
The theoretical literature on the role of diversification in firm valuation is not yet con-
clusive. Agency theory shows one of the critical theoretical motives behind the firm diver-
sification strategy. Agency theory emphasizes that corporate diversification increases the
shareholder’s investment efficiency and is also in management interest (Erdorf et al. 2013).
During the high uncertainty period, corporate diversification increases the firm access to
the internal capital market and helps firms to avoid the high transaction cost of external
capital Matsusaka and Nanda (2002). But Rajan et al. (2000) showed that due to internal
capital market advantage, diversified firms become prone to allocate funds to the division
with fewer investment opportunities, and this misallocation of funds supports the claim of
Jensen (1986) that firms agents derive their benefit through value decreasing diversifica-
tion. In the same notion, Aggarwal and Samwick (2003) explained the two perspectives

1
Apart from the moderating channels between EPU-firm value relationship, various other studies use the
moderating channels to conduct studies. Like, Usman et al. (2022) examined the financial development role
between pollution concern and globalization mode relationship using financially rich countries data. Also,
Sadiq et al. (2022), conducted a study to see the role of external debt and financial globalization on the rela-
tionship between human development, nuclear energy, and carbon emission in BRICS countries. Another
study done by Ke et al. (2022) examines the nexus between information, telecommunication, and technol-
ogy (ICTs), globalization, foreign direct investment, and carbon emission based on 77 developing countries’
data.

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of corporate diversification with respect to agency theory, risk diversification, and private
benefit of agents in one model. Their models suggest that agents diversify the investment to
propagate their own benefits, not for risk reduction. However, when firms have more inter-
nal capital, it creates an agency problem that impacts the firm investment. Additionally, the
self-serving manager and those intending to private benefit from corporate diversification
will obviously invest free cash flow in sub-optimal projects (Glaser et al. 2013), instigat-
ing the agency problem. Denis et al. (1997) stated that the value-reducing diversification
strategies of firms are due to agency problems. Thus, consistent with the agency view, if
managers follow diversification strategies for private motives, the potential benefit of diver-
sification in terms of improving firm value would be minimum.
The second channel through which corporate diversification impacts the firm value is
internal capital access because conglomerates have better access to the internal capital
market as they can use different segments’ assets and cash flow to manage the inconvenient
situation at different segments. However, the internal capital market channel is good if the
cross-subsidization of assets helps to remove the financial constraint but inefficient if the
conglomerate underinvests in a better opportunity segment and vice versa (Erdorf et al.
2013). Due to the fact that conglomerates have better access to the internal capital markets,
they might be less influenced by the adverse effect of EPU-induced financial constrained
(Hoang et al. 2021). Volkov and Smith (2015) show that only financially constrained firms
show improvement during the recessionary period as they have access to the internal capi-
tal market rather than the external capital market. The relative improvement in firm value is
temporary, as this disappears in the next four quarters of the recessionary period. Ni et al.
(2019) stated that firms that take funds for capital budgeting activities could increase the
firm value. Still, from operating activities, the firm value will decline if there is a low-profit
margin. Andreou et al. (2019) suggested that diversified firm run by overconfident CEOs
faces valuation loss in comparison to those diversified firms that are run by rational CEOs.
Yildirim and Efthyvoulou (2018) stated that higher intra-regional diversification would
increase bank value, whereas inter-regional diversification led to value loss in emerging
countries. Whereas, Santalo and Becerra (2008) contend that the diversification impact is
not the same but heterogeneous across different industries, which means that firms may
be traded at a premium in some industries but at a discount in others. Some studies have
shown that corporate diversification is more valuable while the external capital market is
less developed (Fauver et al. 2003). So, there is no consensus about the impact of corpo-
rate diversification on firm value. Besides the lack of consensus on the diversification-firm
value relation, some new empirical studies show a positive link between diversification and
firm value. Bhatia and Thakur (2018) evaluate the causal link between the level of product
diversification and firm performance by employing data from Indian firms. For calculating
product diversification, the authors used the Entropy index. The empirical investigations
report that diversification is strongly and positively related to firm performance. Thus,
it is proved from the results that diversified companies yield substantial diversification
premiums.
Consistent with contrasting theoretical arguments, prior literate also suggests that diver-
sification can be value-increasing and can be value decreasing for firms. On the one hand,
the premium view of diversification contends that diversification enhances operating effi-
ciency (Aivazian et al. (2019), decreases the cost of capital Hann et al. (2013), and benefits
the internal capital market for the firm (Kuppuswamy and Villalonga 2016). Whereas on
the other hand, the discount view of diversification contends that it decreases the corporate
value due to the overinvestment in suboptimal projects, cross-subsidization of the assets
from well-performing to poor performing segments of conglomerate and misallocation of

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resources among different segments of business (Berger and Ofek 1995; Rajan et al. 2000;
Scharfstein and Stein 2000; Stulz 1994). Moreover, another strand of literature discusses
that due to endogeneity, the actual relation between corporate value and diversification
becomes ambiguous. Certain factors that force firms to diversify also impact the corporate
value outcomes, and omitting the endogeneity concern will lead to an obscure valuation of
corporate value and diversification relationship (Campa and Kedia 2002; Villalonga 2005).
Nevertheless, after controlling this concern, there is still conflict as (Campa and Kedia
2002) reported the premium view of diversification, but Hoechle et al. (2012) showed the
diversification discount. When the firm diversifies the business into multiple product seg-
ments, there would be an imperfect correlation among their cash flows, which enables the
firm to reduce the chances of default and increase the investment capacity of the firm. Fur-
ther, Erdorf and Heinrichs (2011) empirically proved that during the crisis period, there
is a structural change in correlation among the revenue of different industries, which has
repercussions for the decision of diversification during portfolio analysis and risk diversifi-
cation. Further, there is a chance of bankruptcy and downside risk due to the high correla-
tion during the crisis period.
The collective view from the discussion is also consistent with the survey study
of (Erdorf et al. 2013), who documented that there has yet to be an obvious consensus
regarding the real effect of diversification on firm value in the last ten years. However,
this effect depends on the specific industry settings, government structures and economic
conditions. Further, although several earlier research studies show that corporate diversi-
fication decreases firm value (Berger and Ofek 1995; Martin and Sayrak 2003), however,
firms worldwide persistently engage in diversification-related activities (Kwon et al. 2021).
The resource-based perspective of corporate diversification advocates the utilization of the
excess resources from one business segment into other segments, assuming that lower pro-
duction cost helps to make more revenue (Teece 1982). Considering that diversification is a
value-enhancing strategy during economic uncertainty, in recent literature, it is evident that
firms started to adopt diversification strategies during EPU. In this respect, recent literature
reported that firms generally adopt more diversification strategies to deal with the higher
risk of EPU and to enhance firm performance (Hoang et al. 2021). Similarly, Volkov and
Smith (2015) reveal a substantial increase in firm value for diversified firms during reces-
sionary times, and they attribute this increase in firm value to the efficient allocation of
internal capital. Kuppuswamy and Villalonga (2016) provide evidence that diversification
generates a value premium during the 2007–2009 financial crisis since the conglomerates
efficiently manage their internal capital. Whereas, specifically for emerging market firms,
corporate diversification increases the firm value (Selçuk 2015). Further, during demand
shocks in the economy, the diversified firm makes a better investment decision (Glaser and
Müller 2010; Khanna and Tice 2001), while diversification helps to moderate the adverse
effect of high EPU on firm investment (Jumah et al. 2022). In addition, the imperfect cor-
relation among the different segments’ cash flows also helps to reduce the default probabil-
ity and increase conglomerates’ resilience (Aivazian et al. 2019; Singhal and Zhu 2013),
which enables diversified firms to enhance their debt financing capacity.
Considering the above discussion, we argued that if diversification is an effective strat-
egy to nullify the adverse effect of economic recession, it can also mitigate the adverse
effect of EPU on firm value. Moreover, consistent with the internal capital market view
and segments cash flows coinsurance that reduces the financial constraints and enhances
firm performance, companies follow a diversification strategy to mitigate financial con-
straints, which is primarily associated with a reduction in firm value and segments cash
flows coinsurance that reduces the financial constraints and enhances firm performance.

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Therefore, the study hypothesizes that corporate diversification increases the firm’s value
under high economic policy uncertainty as it provides the edge of the internal capital mar-
ket and imperfect cash flows of different segments. The second hypothesis is presented in
the following statement.

H2 Corporate diversification moderates the negative effect of EPU on firm value.

3 Research design

3.1 Data and sample

We collect the annual firm-level data for all the non-financial public firms from 22 coun-
tries using Refinitiv DataStream.2 To deal with the impact of the extreme values on our
results, following (Kwon et al. 2021), we exclude any firms with negative total assets and
firms belonging to the utilities (SIC codes 4900-4999) and financial (SIC codes 6000-
6999) services industry. Also, we winsorized all the variables at 1% and 95% levels.
The final sample covers 364,433 firm-year observations of 29,709 unique firms from
twenty-two countries for the period 2000–2020. In Table 1, from columns (1) to (4), we
present the sample distribution with respect to the country and percentage of diversified
firms. Also, from columns (5) to (7), we illustrate the sample distribution by years.

3.2 Variables definition

3.2.1 Dependent variable

Following previous literature, we use Tobin’s Q as a proxy for firm value (Gulen and Ion
2016; Rjiba et al. 2020). It is measured by subtracting the book value of equity from the
market value of equity, then adding the book value of assets, and finally dividing the result
by the book value of asset. There are other formulations of Tobin’s Q as well. For exam-
ple, Tobin’s Q can be expressed as the ratio of a company’s market value of equity to the
replacement cost of its assets. The replacement cost is the cost to replace or reproduce the
company’s assets at their current market prices. This formulation reflects how the market
values the company concerning the expense required to recreate its asset base. Another
measurement shows the calculation as the ratio of a company’s market value of equity to
its book value of equity. The book value of equity represents the accounting value of share-
holders’ equity, and this formulation provides insights into the market’s valuation of the
company’s net worth based on its accounting data. Lastly, we have calculations that can
quantify Tobin’s Q is the ratio of the market value of the entire company to the replace-
ment cost of its assets. It provides an overall measure of the company’s value compared
to the cost of recreating its assets. These formulations of Tobin’s Q provide different per-
spectives on how the market perceives firm value. These measures consider market values,
replacement costs, book values, and asset values, each contributing to a different aspect of
the company’s valuation. The reason for measuring firm value using Tobin’s Q following
(Gulen and Ion 2016; Rjiba et al. 2020) is of market-based proxy as it shows the firm value

2
The data for EPU is collected from www.​polic​yunce​rtain​ty.​com.

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2686 Z. Jumah et al.

Table 1  Sample distribution

(1) (2) (3) (4) (5) (6) (7)
Country Observations (N) % % of firms Year Observations (N) %
diversified

Japan 56,245 15.43 71.79 2000 13,900 3.81

India 34,884 9.57 38.16 2001 14,674 4.03
Australia 33,394 9.16 23.00 2002 15,101 4.14
United States 32,862 9.02 47.56 2003 15,602 4.28
United Kingdom 31,044 8.52 31.39 2004 16,252 4.46
Hong Kong 26,925 7.39 74.40 2005 16,713 4.59
China 24,562 6.74 82.05 2006 17,471 4.79
Canada 20,424 5.60 23.99 2007 17,507 4.80
Sweden 19,400 5.32 36.02 2008 17,377 4.77
South Korea 15,820 4.34 63.96 2009 17,235 4.73
France 14,875 4.08 42.35 2010 17,308 4.75
Germany 12,113 3.32 48.50 2011 17,504 4.80
Singapore 11,826 3.25 34.79 2012 17,608 4.83
Brazil 6172 1.69 31.63 2013 17,976 4.93
Italy 6017 1.65 53.30 2014 18,406 5.05
Greece 5201 1.43 19.63 2015 18,671 5.12
Mexico 4603 1.26 55.73 2016 18,957 5.20
Chile 3359 0.92 38.11 2017 19,295 5.29
Netherlands 2420 0.66 47.48 2018 19,384 5.32
Ireland 1097 0.30 45.55 2019 19,059 5.23
Colombia 775 0.21 19.23 2020 18,433 5.06
Spain 415 0.11 35.42
Grand Total 364,433 100.00 364,433 100.00%

This table depicts the sample summary concerning country and year

with respect to the investor’s perception, unlike the accounting measure of firm perfor-
mance using historical nature data.

3.2.2 Independent variable

To quantify the economic policy uncertainty, we employ the EPU index for Brazil, Aus-
tralia, France, Canada, Germany, India, South Korea, Italy, Mexico, the United Kingdom,
and the United States developed by (Baker et al. 2016). For remaining countries, we use
the EPU index based on the following studies: Chile: (Cerda et al. 2016); China: (Davis
et al. 2019); Colombia: (Gil and Silva 2018); Sweden:(Armelius et al. 2017); Greece:
(Hardouvelis et al. 2018); Ireland: (Zalla 2017); Japan: (Arbatli Saxegaard et al. 2022);
Spain: (Ghirelli et al. 2019); Singapore: (Davis 2016); Hong Kong: (Luk et al. 2020); Neth-
erlands: (Kroese et al. 2015). The EPU index is developed from three different constitu-
ents: (1) news-based EPU, which constitutes half weight of the aggregate EPU measure)
(2) tax-based EPU, which constitutes around one-sixth of the aggregate measure, and (3)
forecaster disagreement-based EPU, which constitutes one-third of the aggregate EPU. The
news-based component of EPU is developed by collecting EPU-related news each month

13
Economic policy uncertainty, corporate diversification and… 2687

and quantifying it. The process comprises of initial search of EPU-related key terms in
the top 10 newspapers, and after that the keywords are counted and summed up for each
month. Eventually, a scale is developed that measures EPU index. The second component
(e.g., the taxed-based EPU) is developed to capture the uncertainty in tax-related policies.
The third component captures the magnitude of forecasting disagreement with future mon-
etary and fiscal policies. BBD use data related to fiscal and monetary policies by getting
data from a survey conducted by professional forecasters from the Federal Reserve Board
of Philadelphia. All three EPU’s components are first normalized to construct an aggregate
measure, and after that, a weighted average index is developed based on the three EPU’s
components. One-half, on-sixth and one-third of the EPU index are captured by the news-
based component, tax-based component, and forecasters’ disagreement component, respec-
tively.3 This index encompasses analyses of policy-related uncertainty published in the top
ten newspapers in the U.S. The rationale behind using this index lies in its ability to capture
a wide range of economic aspects, including general economic conditions, fluctuations in
economic policies, and the prevailing sentiment of the public concerning the overall mac-
roeconomy (Istiak and Serletis 2018; Li et al. 2021).
EPU represents the economic policy uncertainty based on the natural logarithm of the
equally weighted arithmetic mean of the monthly EPU index for the 12 months of the year.
Previous literature shows that the EPU index is a correct measure to gauge prevailing eco-
nomic uncertainty (Bonaime et al. 2018; Gulen and Ion 2016; Jory et al. 2020). Since the
original values of EPU are higher than the other variables in the model, thus, to make it
relatable with other variables, we follow Vural-Yavaş (2020) and Ilyas et al. (2022) by tak-
ing the natural log of the EPU index. The equation to measure the EPU index is as follows.
12
∑
LN(EPU t ) = LN( EPU m ∕12)
m=1

where EPUt denotes the economic policy uncertainty at time t = year, EPUm denotes the
monthly value of the U.S. EPU index.

3.2.3 Moderating variables

Corporate diversification is used as a moderating variable. Two proxies are employed for
corporate diversification: diversification dummy and entropy index. The diversification
dummy variable (CDDum) takes the value ‘1’ for the firms with two or more business seg-
ments and ‘0’ otherwise. Also, this measure is quantified based on related diversification.
Second, using the following formula, the entropy index (CDENindex) is measured follow-
ing (Hoang et al. 2021; Kwon et al. 2021).
NS ( )
∑ 1
CDENindex = Pi ln
i=0
Pi

where CDENindex is the entropy index, N.S. portrays the number of product segments of
a firm, and Pi is the percentage of revenue from segment i in the total revenue. The higher
value of the index shows that firms are more diversified and vice versa.

3
For more detail about the construction of the index. See, Baker et al. (2016) and visit www.​polic​yunce​
rtain​ty.​com.

13
2688 Z. Jumah et al.

3.2.4 Control variable

We use control variables, including firm size, debt ratio, capital expenditure, dividend,
operating cash flow, and sales growth, as important determinants of firm value follow-
ing (Kwon et al. 2021). “Appendix” shows the description and data sources for all these
variables employed during analyses.

3.3 Model

To examine the effect of EPU on firm value, we construct our model as follows.
Qi,t = 𝛽0 + 𝛽1 EPU t + 𝛽2 Controlsi,t + FE.Country + FE.Industry + FE.Year + 𝜀i,t (1)

where Qi,t represents firm value based on Tobin’s Q. EPU represents the economic
policy uncertainty index based on the natural logarithm of the equally weighted
mean of the monthly EPU index. Controlsi,t denotes the firm-level control variable.
F.E.Country, F.E.IndustryandF.E.Year represents the country-, industry- and year-fixed
effects, respectively. The term 𝜀i,t shows the error terms where ‘i’ denotes the firm and ‘t’
indexes for a time in a year. We use an ordinary least square (OLS) regression analysis for
model estimation. Moreover, to examine the moderating impact of diversification between
EPU and firm value relationship, we stretch our model as follows.

Qi,t = 𝛽0 + 𝛽1 EPU t + 𝛽2 CDi,t + 𝛽3 EPU t × CDi,t + 𝛽4 Controlsi,t

(2)
+ FE.Country + FE.Industry + FE.Year + 𝜀i,t

where CDi,t is one of two proxies of corporate diversification using a dummy variable
(CDDum) and entropy index (CDENindex) used by Hoang et al. (2021) and Kwon et al.
(2021). EPU t × CDi,t is one of two interaction variables of EPU and corporate diversi-
fication, i.e. (LnEPU × CDDum) and (LnEPU × CDENindex). The interaction variable
shows the moderating effect of diversification between EPU and firm value relationship.
The remaining model is the same as Eq. (1).

4 Results

4.1 Summary statistics

Table 2 shows the summary statistics for variables employed in the regression model.
The mean of firm value (Q) is 1.363 with standard deviation, minimum and maxi-
mum values of 1.124, 0.206, and 4.628, respectively, showing reasonable variation
among the firms regarding firm value. Also, the mean and standard deviation values of
different corporate diversification measures, along with minimum and maximum, indi-
cate significant variation among firms for diversification level. Next, the natural loga-
rithm of EPU (LnEPU) depicts a mean value of 4.759 with minimum and maximum
values of 3.762 and 5.733, showing significant variation in policy uncertainty during

13
Economic policy uncertainty, corporate diversification and… 2689

Table 2  Summary statistics

Variables Symbols Observations (N) Mean SD Min Max

CD-Dummy CDDum 364,433 0.783 0.412 0.000 1.000

CD-Entropy Index CDENindex 364,433 0.176 0.333 0.000 1.059
CD-Caves index CDCavesindex 364,631 1.098 0.983 0.000 2.000
CD-Herhindhal Index CDHFindex 268,051 0.302 0.258 0.000 0.718
Excess value EV 274,412 0.063 1.770 − 4.128 3.921
EPU LnEPU 613,759 4.759 0.472 3.762 5.733
Size Size 364,433 14.034 3.252 6.510 19.552
Firm value Q 322,969 1.363 1.124 0.206 4.682
Debt ratio Debt 361,901 0.219 0.192 0.000 0.628
Capital expenditure Capex 351,704 0.048 0.051 0.000 0.190
Dividend Div 276,939 0.012 0.017 0.000 0.061
Sales growth SG 323,593 0.104 0.358 − 0.933 1.059
Operating cashflow OperCF 348,754 0.026 0.276 − 1.707 0.267

The table presents the summary statistics of all variables used in the regression analysis for models (1) and
(2)

different periods. The control variables, including debt ratio, firm size, capital expendi-
ture dividend, operating cash flow, and sales growth, show enough variation among the
selected firms.

4.2 Regression analysis

Table 3 illustrates the results using ordinary least regression analysis based on models (1)
and (2).
In Column (1), based on model (1), we check the direct effect of EPU on the firm value
after controlling firm value determinants along with the year, industry, and country-fixed
effects. This table reports both the direct impact of EPU on firm value (Q) and the interac-
tion effect with corporate diversification (e.g., LnEPU × CDDum and LnEPU × CDENin-
dex). First, in Column 1, the direct impact of EPU on Q yields a negative coefficient
(− 0.153) with a t-stats of (− 20.793). These estimates show a significant negative impact
of EPU on firm value at the 1% level, showing that firm value decreases due to policy-
engendered uncertainty. The coefficient of − 0.153 means that for every unit increase in
EPU, the firm’s value decreases by approximately 0.153 units. Hence, our first hypothesis
that "policy uncertainty negatively affects firm value" is accepted. The likely reason is that
increased financial constraints arise from information asymmetry between lenders and bor-
rowers, ultimately affecting the firm’s value.
The finding on the negative EPU-FV nexus is aligned with the view that EPU exacer-
bates financial constraints due to increased cost of financing and high information asym-
metry, thereby negatively affecting firm performance (Iqbal et al. 2020; Liu and Zhang
2015; Mirza and Ahsan 2020). The findings also support the view that EPU leads manage-
ment to restrict their investment and adopt risk-averse policies (Chatjuthamard et al. 2020).
The shift towards risk-averse policies may put extra pressure on cash flow generation, thus,
resulting in lower firm value (Vural-Yavaş 2020). In addition, a survey study by Campello

13
2690 Z. Jumah et al.

Table 3  Baseline results Variables (1) (2) (3)

(Q) (Q) (Q)

Size − 0.123*** − 0.120*** − 0.123***

(− 98.119) (− 95.505) (− 94.840)
Debt 0.046*** 0.055*** 0.047***
(3.889) (4.608) (3.928)
Capex 1.458*** 1.441*** 1.458***
(33.163) (32.820) (33.176)
Div 14.730*** 14.649*** 14.729***
(116.393) (115.877) (116.334)
OperCF − 0.406*** − 0.410*** − 0.405***
(− 41.514) (− 41.958) (− 41.441)
SGrowth 0.304*** 0.303*** 0.304***
(32.746) (32.694) (32.739)
LnEPU − 0.153*** − 0.170*** − 0.166***
(− 20.793) (− 15.715) (− 21.663)
CDDum − 0.233***
(− 4.595)
LnEPU × CDDum 0.022**
(2.078)
CDENindex − 0.355***
(− 6.060)
LnEPU × CDENindex 0.075***
(6.077)
Constant 2.432*** 2.607*** 2.493***
(7.169) (7.647) (7.347)
Year FE ✓ ✓ ✓
Industry FE ✓ ✓ ✓
Country FE ✓ ✓ ✓
N 227,226 227,226 227,226
Adj ­R2 0.313 0.315 0.313

All the variable descriptions are shown in “Appendix”. Robust t-sta-

tistics are shown in brackets. ***, ** and * denotes statistical signifi-
cance at 1%, 5% and 10% levels, respectively

et al. (2010) documented that information asymmetry induces financial constraints, which
adversely affects firm performance, as 85% of the financially constrained firm’s CFOs
demonstrate that they were contrived to renounce profitable investments.
In Column (2), we extended model (1) and incorporated a corporate diversification
dummy and its interaction with EPU (LnEPU × CDDum) to evaluate the moderating
impact of corporate diversification between EPU and firm value as shown in model (2).
The interaction variable between EPU and diversification (LnEPU × CDDum) shows a
positive and significant impact on firm value at a 5% level with a coefficient of 0.022**
and t-stats of 2.078, which implies that diversification moderates the adverse effect of
EPU on firm value. Thus, diversified firms can sustain their market performance during

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Economic policy uncertainty, corporate diversification and… 2691

policy uncertainty. The coefficient of 0.022 means that for every unit increase in the inter-
action between EPU and diversification, the firm’s value increases by about 0.022 units.
To explain it simply, when a company is diversified, it acts as a shield during uncertain
economic times, helping to protect its value and even increase it. Additionally, in Column
(3), we use an Entropy-index based measure of diversification as an alternate measure
and rerun model (2) regression model. However, the interaction term (LnEPU × CDENin-
dex) also shows a positive moderating effect on firm value at the 1% significance level
with a coefficient of 0.075*** and t-stats of 6.077. The coefficient of 0.075 means that for
every unit increase in the interaction between EPU and the Entropy index, the firm’s value
increases by approximately 0.075 units. Thus, these results support our second hypothesis
that diversification mitigates the adverse effect of EPU on firm value. Briefly, the evidence
suggests that firm value is not affected by the EPU in diversified firms since these gener-
ally face fewer financial constraints due to their access to internal capital. This phenom-
enon is because conglomerate firms generally have better access to internal capital as they
can effectively utilize several segments’ cash flow and assets to handle adverse situations
(Aivazian et al. 2019). The results are also consistent with the view that the effect of diver-
sification also depends on various factors, including economic conditions Erdorf et al.
(2013), which means that diversification generates more value for the firms during uncer-
tain economic conditions (Volkov and Smith 2015).
The regression estimates for the control variable also align with the previous studies.
Dividend, capital expenditure, debt ratio, and sales growth positively and significantly
affect the firm value at 1%. Level. The positive nexus between firm value and dividends
suggests that dividends paying firms have better operating and market performance. More-
over, increased investment in capital expenditures positively influences firm performance.
Similarly, the positive relation between debt ratio and firm performance suggests that firms
with reliable performance keep more debt. Moreover, the results suggest that sales growth
positively impacts firms’ performance. This evidence aligns with the results of (Azimli
2023; Rjiba et al. 2020).

4.3 Robustness check for endogeneity and selection‑bias

In this section, we perform several robustness tests to deal with endogeneity and selection
bias related to the baseline results. First, we employ the propensity score matching (PSM)
technique to eradicate the selection-bias concern.
The purpose of PSM analysis is to randomize the procedure of sample selection by
matching diversified and non-diversified firms with observable firm-based characteristics.
To perform the PSM analysis, we follow the process followed by (Rjiba et al. 2020). First,
we generate a Diversification dummy that takes the value ‘1’ when a firm is diversified
and ‘0’ otherwise and classify the total number of observations into treatment (Diversifi-
cation dummy = 1) and control (diversification dummy = 0) subsets. After that, in the first
stage, we evaluate the propensity scores by applying logistic regression, which regresses
the Diversification dummy on the control variable used in the baseline regression model.
In the second stage, we match the diversified and non-diversified firms with the closest
propensity score derived from the first stage. The firms are matched based on the nearest
propensity scores from treatment (diversified) and control (non-diversified) groups. All the
observations from the treatment and control groups that were not matched based on one-
to-one matching criteria were excluded from the sample. Thus, the matched sample exhibit

13
2692 Z. Jumah et al.

Table 4  Robustness check for endogeneity and selection-bias

Variables Propensity score matching (PSM) analysis Two-stage least square (2SLS) analysis

(1) (2) (3) (4) (5) (6)

(Q) (Q) (Q) (Q) (Q) (Q)

LnEPU − 0.160*** − 0.199*** − 0.176***

(− 7.546) (− 6.668) (− 8.055)
LnEPU(Predicted) − 1.320*** − 1.324*** − 1.343***
(− 9.897) (− 9.895) (− 10.059)
CDDum − 0.415*** − 0.221***
(− 3.043) (− 3.698)
LnEPU × CDDum 0.056**
(2.010)
CDENindex − 0.567*** − 0.225***
(− 3.339) (− 3.336)
LnEPU × CDENindex 0.110***
(3.110)
LnEPU(Predicted) × CDDum 0.023*
(1.882)
LnEPU(Predicted) × CDENindex 0.051***
(3.599)
Constant 3.071*** 3.335*** 3.129*** 7.693*** 7.783*** 7.806***
(4.445) (4.785) (4.526) (11.305) (11.408) (11.461)
Control variables ✓ ✓ ✓ ✓ ✓ ✓
Year FE ✓ ✓ ✓ ✓ ✓ ✓
Industry FE ✓ ✓ ✓ ✓ ✓ ✓
Country FE ✓ ✓ ✓ ✓ ✓ ✓
N 35,028 35,028 35,028 229,476 229,476 229,476
Adj ­R2 0.276 0.278 0.276 0.312 0.313 0.312

All the variable descriptions are shown in “Appendix”. Robust t-statistics are shown in brackets. ***, **
and * denotes statistical significance at 1%, 5% and 10% levels, respectively

qualitatively similar attributes irrespective of whether they are from the diversified firms
(treatment group) or non-diversified firms (control group). As a result, the overall firm-year
observations were reduced to 35,028, which enables us to address the selection-bias issue.
In the last stage, we re-estimated the baseline analysis using matched sample. Table 4, Col-
umns (1) to (3) shows that the results for PSM analysis which are consistent with baseline
results.
In addition, we also run the two-stage least square (2SLS) estimation to deal with endo-
geneity. As some common factors simultaneously impact the EPU and firm value, EPU
may not be an exogenous variable. Since general elections are exogenous factors of elevated

13
Economic policy uncertainty, corporate diversification and… 2693

policy uncertainty (Baker et al. 2016; Gulen and Ion 2016), we use an election year dummy
variable as an instrumental variable for EPU and employ a two-stage least square (2SLS)
analysis procedure. For brevity, we illustrate the results for the second stage of 2SLS analy-
sis in Table 4, columns (4) to (6), which are aligned with our baseline results.4

4.4 Sensitivity test

In this section, we use alternate measures for firm value, corporate diversification, and
EPU to validate the sensitivity of our baseline results with substitute measures. We use a
firm’s Excess value as an alternate measure for firm value following the study of (Berger
and Ofek 1995). Panel A of Table 5 presents the results with the firm’s excess value in col-
umns (1) to (3) and shows consistency with baseline results.
We also use two alternative proxies for diversification, namely the Caves index and the
modified Herfindahl index following the study (Aivazian et al. 2019; Kwon et al. 2021).
The Caves index quantifies firm-level diversification based on related and unrelated busi-
ness lines, thus giving a more robust measure of diversification. Also, the modified Her-
findahl index is based on multiple segment sales compared to the Entropy index, which is
based on revenue from each segment. The results using alternate measures of diversifica-
tion are shown in Panel A of Table 5 from columns (4) to (6). These results are also aligned
with baseline analysis.
Further, for alternate measurement of the EPU index, following (Hong and Quang 2022;
Nguyen and Phan 2017), we use the last three and six months’ equally weighted mean
of the monthly EPU index identified as LnEPU3 and LnEPU6, respectively. Panel B of
Table 5 illustrates the results with LnEPU3 and LnEPU6 in columns (1) to 3 and (4) to (6),
respectively. The results with an alternate measure of EPU are also aligned with baseline
results. The calculation and description of all the alternative measures for firm value, cor-
porate diversification, and EPU are shown in “Appendix”.

4.5 Subsampling and mechanism analysis

Table 1 shows that Japanese, Indian, Australian, and United States firms cover more than
40% of total sample observations. Hence, these four countries’ firms’ observations drive
our baseline findings. To address this concern, we revise the baseline regression analysis
after excluding the firms from Japan, India, Australia, and the United States. Table 6, col-
umns (1) to (3), shows that the results with subsampling continue to hold with baseline
analysis.5
Lastly, we examine how corporate diversification can potentially moderate the adverse
impact of high uncertainty on firm value. We examine financial constraints as a proba-
ble channel that may navigate the negative impact of high EPU through corporate diver-
sification on firm value following (Aivazian et al. 2019; Jumah et al. 2022). Since dur-
ing high EPU, the information asymmetry between lenders and borrowers spikes the cost

4
For brevity, regression results for control variables are not reported in all the results except for baseline
results.
5
In unreported results, following (Jumah et al. 2022; Suh and Yang 2021), we rerun our baseline results
using data sample after excluding financial crisis years (year excluded 2007–2009), sample after financial
crises years (2010–2020) and sample excluding Covid-19 years (2000–2018). Also, we rerun the baseline
results by clustering the robust standard errors at the firm level. In all the specifications, our results align
with the baseline findings.

13
2694 Z. Jumah et al.

Table 5  Panel A: Sensitivity test; Panel B: Sensitivity test

Variables Excess value (E.V.) as an alternate Caves and Modified-Herfindahl index
measure of Firm value (Q) as an alternate measure of corporate
diversification

(1) (2) (3) (4) (5) (6)

(E.V.) (E.V.) (E.V.) (Q) (Q) (Q)

Panel A
LnEPU − 0.045*** − 0.093*** − 0.070*** − 0.153*** − 0.171*** − 0.149***
(− 4.379) (− 6.041) (− 6.483) (− 20.793) (− 23.038) (− 15.830)
CDDum − 0.376***
(− 5.286)
LnEPU × CDDum 0.056***
(3.817)
CDENindex − 0.635***
(− 8.374)
LnEPU × CDENindex 0.110***
(6.961)
CDCavesindex 0.002
(1.479)
LnEPU × CDCavesindex 0.011***
(18.516)
CDHFindex − 0.442***
(− 5.124)
LnEPU × CDHFindex 0.063***
(3.512)
Constant − 1.810*** − 1.490*** − 1.750*** 2.432*** 2.575*** 2.223***
(− 3.699) (− 3.025) (− 3.576) (7.169) (7.597) (6.279)
Control variables ✓ ✓ ✓ ✓ ✓ ✓
Year FE ✓ ✓ ✓ ✓ ✓ ✓
Industry FE ✓ ✓ ✓ ✓ ✓ ✓
Country FE ✓ ✓ ✓ ✓ ✓ ✓
N 214,015 214,015 214,015 227,226 227,226 192,358
Adj ­R2 0.525 0.525 0.525 0.313 0.314 0.313
Variables LnEPU3 as an alternate measure of the LnEPU6 as an alternate measure of the
LnEPU index LnEPU index

(1) (2) (3) (4) (5) (6)

(Q) (Q) (Q) (Q) (Q) (Q)

Panel B
LnEPU3 − 0.123*** − 0.147*** − 0.136***
(− 18.460) (− 15.111) (− 19.539)
LNEPU6 − 0.131*** − 0.151*** − 0.144***
(− 19.740) (− 15.457) (− 20.625)
CDDum − 0.277*** − 0.247***
(− 6.115) (− 5.370)
CDENindex − 0.327*** − 0.315***

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Economic policy uncertainty, corporate diversification and… 2695

Table 5  (continued)
Variables LnEPU3 as an alternate measure of the LnEPU6 as an alternate measure of the
LnEPU index LnEPU index

(1) (2) (3) (4) (5) (6)

(Q) (Q) (Q) (Q) (Q) (Q)

(− 6.399) (− 5.950)
LnEPU3 × CDDum 0.031***
(3.300)
LnEPU3 × CDENindex 0.069***
(6.442)
LnEPU6 × CDDum 0.025***
(2.600)
LnEPU6 × CDENindex 0.066***
(5.977)
Constant 2.334*** 2.542*** 2.392*** 2.356*** 2.542*** 2.411***
(6.878) (7.463) (7.049) (6.947) (7.467) (7.108)
Control variables ✓ ✓ ✓ ✓ ✓ ✓
Year FE ✓ ✓ ✓ ✓ ✓ ✓
Industry FE ✓ ✓ ✓ ✓ ✓ ✓
Country FE ✓ ✓ ✓ ✓ ✓ ✓
N 226,702 226,702 226,702 226,860 226,860 226,860
Adj ­R2 0.313 0.315 0.313 0.313 0.315 0.313

All the variable descriptions are shown in “Appendix”. Robust t-statistics are shown in brackets. ***, **
and * denotes statistical significance at 1%, 5% and 10% levels, respectively.

of capital; thus, firms face financial constraints. However, diversified companies mitigate
financial constraints by pooling the cash flow of various business segments, commonly
called cash flow coinsurance (Kuppuswamy and Villalonga 2016; Lewellen 1971; Stein
2003). To determine if diversified firms can reduce the adverse impact of high EPU on
their firm value through the financial constraints channel, we expand model (2) by includ-
ing a three-way interaction term between EPU, diversification, and financial constraints
(LnEPU × CD × F.C.) as well as the financial constraints variable (F.C.). The results are
shown in Table 6, Columns (4) to (6). The estimates of LnEPU and F.C. show a nega-
tive impact on firm value in Column (4). However, in columns (5) and (6), the three-way
interaction positively impacts firms’ value, implying that diversification helps alleviate the
adverse effect of EPU on firm value by mitigating financial constraints.

4.6 Additional analysis

In an additional analysis, we use related and unrelated corporate diversification measures,

divide the total sample based on Morgan Stanley Capital International (MSCI) developed
and emerging economies classification, and rerun the baseline results separately. Table 7,
columns (1) to (4) illustrates the additional analysis results where diversification positively
moderates the adverse impact of EPU on firm value for the developed economies firms
based on related and unrelated diversification measures.

13
2696 Z. Jumah et al.

Table 6  Subsample analysis and mechanism analysis

Variables Subsample analysis Mechanism analysis

(1) (2) (3) (4) (5) (6)

(Q) (Q) (Q) (Q) (Q) (Q)

LnEPU − 0.104*** − 0.130*** − 0.124*** − 0.174*** − 0.219*** − 0.203***

(− 10.794) (− 8.639) (− 12.378) (− 23.555) (− 20.052) (− 26.404)
F.C − 0.159*** − 0.156*** − 0.161***
(− 81.492) (− 76.393) (− 78.679)
CDDum − 0.261*** − 0.400***
(− 3.738) (− 7.875)
LnEPU × CDDum 0.028**
(1.999)
LnEPU × CDDum × FC 0.001***
(5.536)
CDENindex − 0.518*** − 0.787***
(− 7.092) (− 13.684)
LnEPU × CDENindex 0.104***
(6.881)
LnEPU × CDENindex × FC 0.002***
(13.475)
Constant 2.574*** 2.794*** 2.653*** 13.454*** 13.558*** 13.723***
(7.652) (8.196) (7.882) (36.223) (35.667) (36.621)
Control variables ✓ ✓ ✓ ✓ ✓ ✓
Year FE ✓ ✓ ✓ ✓ ✓ ✓
Industry FE ✓ ✓ ✓ ✓ ✓ ✓
Country FE ✓ ✓ ✓ ✓ ✓ ✓
N 125,607 125,607 125,607 227,226 227,226 227,226
Adj ­R2 0.314 0.316 0.315 0.304 0.306 0.305

All the variable descriptions are shown in “Appendix”. Robust t-statistics are shown in brackets. ***, **
and * denotes statistical significance at 1%, 5% and 10% levels, respectively

Further, columns (5) to (7) show the results for the firms that belong to emerging
economies, where the interaction terms of EPU and diversification remain negative and
significant based on related diversification measures. However, in Column (8), corporate
diversification positively moderates the relationship between EPU and firm value based
on unrelated diversification measures. Our additional analysis shows that both related and
unrelated corporate diversification in developed economies can be instrumental in mitigat-
ing the negative impact of high EPU on firm value. In emerging economies, only unrelated
diversification effectively deals with high EPU. These results also align with the previous
literature, which shows that unrelated diversification is helpful for emerging markets (Pur-
kayastha et al. 2012).

13
 Table 7  Additional analysis
Variables Result for developed economies’ firms Result for emerging economies firms

(1) (2) (3) (4) (5) (6) (7) (8)

(Q) (Q) (Q) (Q) (Q) (Q) (Q) (Q)

LnEPU − 0.019** − 0.091*** − 0.052*** − 0.039*** − 0.266*** − 0.190*** − 0.236*** − 0.283***

(− 1.962) (− 6.410) (− 5.095) (− 4.002) (− 24.367) (− 11.303) (− 20.685) (− 23.468)
CDDum − 0.549*** 0.389***
(− 8.451) (4.765)
LnEPU × CDDum 0.084*** − 0.097***
(6.324) (− 5.596)
CDENindex − 0.769*** 1.004***
(− 11.282) (9.042)
LnEPU × CDENindex 0.160*** − 0.211***
(11.279) (− 8.916)
Economic policy uncertainty, corporate diversification and…

CDCavesindex 0.001 − 0.011

(1.374) (− 0.828)
LnEPU × CDCavesindex 0.010*** 0.012***
(16.226) (3.776)
Constant 1.944*** 2.395*** 2.089*** 2.096*** 3.695*** 3.381*** 3.566*** 3.811***
(5.704) (6.960) (6.128) (6.153) (34.071) (27.274) (32.426) (34.329)
Control variables ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓
Year FE ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓
Industry FE ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓
Country FE ✓ ✓ ✓ ✓ ✓ ✓ ✓ ✓
Observations 171,674 171,674 171,674 171,674 55,552 55,552 55,552 55,552
Adj R2 0.3099 0.3122 0.3104 0.3113 0.4077 0.4085 0.4085 0.4086

All the variable descriptions are shown in “Appendix”. Robust t-statistics are shown in brackets. ***, ** and * denotes statistical significance at 1%, 5% and 10% levels,
2697

respectively

13
2698 Z. Jumah et al.

5 Discussion of results

The results of our research study provide valuable insights into the relationship between EPU,
corporate diversification, and firm value. Based on the regression analysis, we find signifi-
cant evidence supporting the hypothesis that policy uncertainty has a negative impact on firm
value. The negative coefficient of EPU indicates that an increase in policy uncertainty leads
to a decrease in firm value. This finding aligns with previous studies that have highlighted
the adverse effects of policy uncertainty on firm performance (Ahsan and Qureshi 2021;
Feng et al. 2021; Iqbal et al. 2020). Since, the periods of high policy uncertainty may result in
heightened information asymmetry between lenders and borrowers, leading to elevated financ-
ing costs and financial constraints for firms, impacting their value.
Furthermore, our study is first to investigate the moderating role of corporate diversifica-
tion in mitigating the negative impact of policy uncertainty on firm value. The results reveal
that corporate diversification plays a significant moderating role in alleviating the adverse
effect of policy uncertainty on firm value. Both the corporate diversification dummy and the
entropy-based measure of diversification show a positive and significant interaction with EPU,
indicating that diversification mitigates the negative impact of policy uncertainty on firm
value. Diversified firms are better equipped to handle financial constraints during uncertain
periods due to their access to internal capital and the ability to utilize the cash flow and assets
of various business segments (Aivazian et al. 2019).
The robustness checks conducted in our study further support the validity of the results.
The propensity score matching (PSM) analysis addresses selection bias concerns and confirms
the consistency of the results. The two-stage least square (2SLS) estimation is used to deal
with endogeneity, and the results align with the baseline findings. Sensitivity tests using alter-
native measures for firm value, corporate diversification, and EPU demonstrate the robustness
of the results, as they consistently support the main findings. In addition, we conducted sub-
sample analyses to examine the impact of our four largest country samples (Japan, India, Aus-
tralia, and the United States) on the results. The subsampling results confirm the robustness of
the baseline findings, suggesting that the relationship between EPU, corporate diversification,
and firm value holds even when excluding observations from these countries. Furthermore,
we explored the mechanism through which corporate diversification mitigates the adverse
impact of policy uncertainty on firm value. Our analysis suggests that financial constraints
function as a channeling factor in this relationship. Diversified firms can pool cash flow from
various business segments, which helps them overcome financial constraints caused by high
policy uncertainty. This finding is in line with previous studies highlighting the role of cash
flow coinsurance in mitigating financial constraints and improving firm performance (Kup-
puswamy and Villalonga 2016; Lewellen 1971; Stein 2003).
Lastly, additional analyses were conducted to examine the impact of corporate diversifica-
tion in developed and emerging economies separately. The results indicate that both related
and unrelated corporate diversification positively moderate the adverse impact of policy
uncertainty on firm value in developed economies. However, in emerging economies, unre-
lated diversification is only effective in mitigating the adverse effects of policy uncertainty.
This finding suggests that the effectiveness of diversification strategies may vary depending on
the economic context.
Overall, our study provides robust empirical evidence supporting the negative effect of
policy uncertainty on firm value and highlights the role of corporate diversification in miti-
gating this negative effect. These findings have important implications for managers and
policymakers, emphasizing the importance of managing policy uncertainty and considering

13
Economic policy uncertainty, corporate diversification and… 2699

diversification strategies as a potential tool for improving firm performance during uncertain
periods.

6 Conclusion

We provide novel evidence about corporate diversification’s moderating role between EPU
and firm value relationship. Using the firm-level panel data of twenty-two countries, we
illustrate that corporate diversification offsets the adverse effect of EPU on firm value. The
mechanism analysis shows that the positive mitigating role of corporate diversification
between EPU and firm value works through easing the financial constraints. Thus, corpo-
rate diversification mitigates the information asymmetry-induced financial constraints dur-
ing high EPU and sustains firm value. Another plausible elucidation for these results under
the shed of real options theory suggests that diversified firms assert minor precautionary
delays over non-diversified firms as the diversified firms’ investments are less prone to be
impacted by high EPU (Jumah et al. 2022). Also, the additional analysis shows that in
developed economies, both related and unrelated corporate diversification can effectively
decrease the negative effect of high EPU on firm value. In emerging economies, only unre-
lated diversification is instrumental in dealing with high EPU.
This research study adds scientific value to existing literature in numerous ways. Firstly,
it provides robust empirical evidence on the negative impact of policy uncertainty on firm
value, adding to the body of knowledge on the effects of policy uncertainty on firm perfor-
mance, reinforcing the findings of previous studies (Feng et al. 2021; García-Gómez et al.
2021; Iqbal et al. 2020). Secondly, the study examines the moderating impact of corporate
diversification in mitigating the adverse effect of policy uncertainty on firm value. By high-
lighting the positive interaction between diversification and policy uncertainty, the study
contributes to understanding how firms can navigate uncertain economic environments.
Furthermore, the study identifies financial constraints as a channeling factor in the relation-
ship between diversification and firm value, deepening the understanding of the underlying
mechanisms. Lastly, the study extends the analysis to differentiate between developed and
emerging economies, providing insights into the effectiveness of diversification strategies
in different economic contexts.
The findings of this research study have important implications for both managers and
policymakers. For managers, the study highlights the significance of managing policy
uncertainty and considering diversification strategies as a potential tool for improving
firm performance during uncertain periods. The results suggest that corporate diversifica-
tion can help alleviate the adverse impact of policy uncertainty on firm value by easing
financial constraints. Therefore, managers may consider diversifying their business opera-
tions to access internal capital and utilize the cash flow and assets of various business seg-
ments during times of high policy uncertainty. From a policymaker’s perspective, the study
emphasizes the detrimental effects of policy uncertainty on firm value and the business
environment. Policymakers should recognize high policy uncertainty as a threat to busi-
ness environment stability and take measures to reduce uncertainty and provide a more
favorable environment for businesses. By addressing policy uncertainty, policymakers can
promote economic growth and support firm value.
Despite its contributions, our research study has some limitations that need to be
acknowledged. Firstly, the study relies on panel data from twenty-two countries, which
may need to fully capture the diversity of global economic conditions. Future studies could

13
2700 Z. Jumah et al.

enlarge the sample size to take in a more comprehensive set of countries. Secondly, the
study focuses on the impact of EPU on firm value and the moderating role of corporate
diversification, overlooking other potential factors that may influence firm performance.
Future studies could explore additional variables to provide a more comprehensive anal-
ysis. Lastly, the study relies on quantitative analysis and does not delve into qualitative
aspects, such as the specific strategies firms employ to manage policy uncertainty. Includ-
ing qualitative research methods could provide deeper insights into firms’ decision-making
processes and strategies in uncertain environments.
Overall, despite these limitations, the research study makes a significant contribution to
the literature by providing empirical evidence, insights into the moderating role of corpo-
rate diversification, and a mechanism analysis that deepens the understanding of the rela-
tionship between policy uncertainty, corporate diversification, and firm value. The findings
have practical implications for managers and policymakers, emphasizing the importance
of managing policy uncertainty and considering diversification strategies to alleviate the
adverse effects of EPU on firm performance and value.

Appendix: Variable definition

Variables Variable Symbol Description Source

Name

Firm value Dependent Q (Market value of equity − Book value Refinitiv Data-
of equity + Book value of total Stream
assets)/(Book value of total assets)
following the study (Gulen and Ion
2016)
Excess value Dependent E.V We measured the Excess value based Same as above
(Alternate on the natural logarithm of the
Measure) firm’s excess value following the
study of (Berger and Ofek 1995).
A diversified firm’s excess value is
the ratio of the actual market value
of the firm to the sum of its imputed
value of each business segment.
Each firm segment’s imputed value
is based on its sales multiplied by
the corresponding industry-median
capital-to-sales ratio
Firm size Control Size Firm size is measured by taking the Same as above
natural logarithm of the firm’s total
assets at time t
Debt ratio Control Debt The debt ratio is calculated by divid- Same as above
ing the firm’s total debt by its total
assets at time t
Capital Control Capex Firm investment is calculated by Same as above
expenditure dividing the total capital expenditure
of the firm by its total assets at time t
Dividend Control Div The dividend ratio is a common share Same as above
dividend to total assets at time t

13
Economic policy uncertainty, corporate diversification and… 2701

Variables Variable Symbol Description Source

Name
Operating cash Control OperCF The firm’s operating cash flow is Same as above
flow calculated by dividing the operating
cash flow by total assets at time t
Sales growth Control SGrowth The sales growth of the firm is a Same as above
dummy measure with a value of ‘1’
where a firm has positive growth and
‘0’ otherwise. This measure adjusted
the firms’ sales growth by the
median sales growth of its respective
industry based on 4-digit SIC codes
in the same country and year
EPU Independ- LnEPU Economic policy uncertainty is Data gathered
ent measured using the natural logarithm from the
of the equally-weighted arithmetic website; www.​
mean of the monthly EPU index for polic​yunce​rtain​
the 12 months of the year, developed ty.​com
by (Baker et al. 2016). The equation
is as follows ∑
12
LN(EPU t ) = LN( m=1 EPU m ∕12)
where, EPUt denotes the economic
policy uncertainty at time t = year,
EPUm denotes the monthly value of
the U.S. EPU index and 12 denotes
12 months of the year
EPU3 Independ- LnEPU3 Instead of 12 months, equally-weighted Same as above
ent arithmetic mean, we use the last three
(Alternate months’ EPU index arithmetic mean
Measure) and take the natural logarithm of it as
an alternate measure of EPU follow-
ing the study of (Hong and Quang
2022; Nguyen and Phan 2017)
∑3
LN(EPU t ) = LN( m=1
EPU m ∕3)
where, EPUt denotes the economic
policy uncertainty at time t = year,
EPUm denotes the monthly value of
the U.S. EPU index and 3 denotes
last three months of the year
EPU6 Independ- LnEPU6 Instead of 12 months, equally- Same as above
ent weighted arithmetic mean, we use
(Alternate the last six months EPU index
Measure) arithmetic mean and take the natural
logarithm of it as an alternate meas-
ure of EPU following the study of
(Hong and Quang 2022; Nguyen and
Phan 2017)
∑6
LN(EPU t ) = LN( m=1
EPU m ∕6)
where, EPUt denotes the economic
policy uncertainty at time t = year,
EPUm denotes the monthly value of
the U.S. EPU index and 6 denotes
last six months of the year
Diversification Moderator CDDum Diversification measure based on Refinitiv Data-
dummy dummy variable takes the value ‘1’ Stream
for the firms with two or more busi-
ness segments and ‘0’ otherwise

13
2702 Z. Jumah et al.

Variables Variable Symbol Description Source

Name
Diversifica- Moderator CDENindex Diversification proxy using Entropy Same as above
tion index Index, measured
∑NSas follows
(Entropy) CDENindex = i=0 Pi 𝐥𝐧( P1 )
i

Where NS is many business segments

in the conglomerate. Pi shows the
income proportion from individu-
alsegment i in the total income of
the conglomerate. The greater value
of the index shows a high diversifi-
cation level and vice-versa
Diversifica- Moderator CDCavesindex This Caves diversification measure Same as above
tion index (Alternate captures the diversification in terms
(Caves) Measure) of relatedness and unrelatedness
from its base industry. We measure
the Caves
∑K index as follows
C.I = K=1 Pk × DkH
where k is the total product segments
of the firm, Pk is the sales percent-
age of k product to the firm’s total
sales. DkH takes the value ‘0’ if
the segment N belongs to the same
four-digit SIC as its based product
H and takes the value ‘1’ if the
segment N has a different four-digit
SIC from its base product H but the
same three-digit SIC as the based
product H, and takes the value ‘2’ if
the segment N has different two-digit
SIC from its base product H. The
higher the value, shows greater the
unrelated diversification level. See
(Bae et al. 2011) for extensive detail
on Caves-index measurement
Diversifica- Moderator CDHFindex Diversification measure based on the Same as above
tion index (Alternate modified Herfindahl index is calcu-
(Modified Measure) lated as follows
∑Z ∑Z
Herfindahl) M.𝐇.𝐈𝐧𝐝𝐞𝐱 = 1 − i=1
(Si∕ i=1
Si)2
We measure across Z business seg-
ments of the firm, taking the sum
of the square of each business
segment i’s sales, Si, as a ratio of
the total sale of the firm. After this,
the value of the Herfindahl index is
subtracted from 1 to get the modified
Herfindahl index as a measure of
diversification. If the value is close
to ‘0’, the less diversified the firm is,
and vice-versa. There is no defined
standard for SIC code levels, and
we use three- and four-digit codes to
measure the caves index

13
Economic policy uncertainty, corporate diversification and… 2703

Variables Variable Symbol Description Source

Name
Financial Mechanism F.C Financial constraints measured as Same as above
constraints analysis FC = {(− 0.737 × firm
channel size) + (0.043 × (firm
size)2) − (0.040 × firm age)},
following the study of (Hadlock and
Pierce 2010)

Funding This study was conducted without external funding or financial support.

Declarations
Conflict of interest The authors state that they have no competing financial interests or personal relationships
that could have influenced the study.

Ethical approval Not applicable.

Consent to participate Not applicable.

Consent to publish Not applicable.

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