Essays on the Firm-level Effects of Geopolitical Risk

Geopolitical uncertainty influences the decisions and policies we make in every aspect of life. The last five decades have seen a constant and significant increase in geopolitical events, such as the Soviet Union's invasion of Afghanistan, the Persian Gulf War, the World Trade Centre attack, the US–China trade war, the Russia–Ukraine war, the Israel–Gaza war, the Israel–Iran war, and Trump’s tariffs. All of this uncertainty has shifted the world's focus towards geopolitical conflict and the business risks this brings. Given the sustained increase in geopolitical conflicts, a growing body of literature is exploring the effects of geopolitics on corporations. Extant studies examine cash holdings, mergers & acquisitions, stock liquidity, investments, the cost of financing, and more. This thesis further adds to this stream of literature by presenting three essays, each examining a different impact of geopolitical risk (GPR). These three areas are corporate default risk, informal financing, and sustainable practices.Financial stability is the foundation of sustained success for an enterprise. It reflects the firm's ability to manage various risks, fulfil financial commitments, and maintain operations. In other words, it reflects resilience. Driven by the critical role that financial stability plays in economic resilience, the first essay investigates the influence of GPR on default risk for S&P 1500 non-financial firms listed over the period 1991 to 2019. Through the lens of pecking order theory, this study reveals an increase in the risk of firms defaulting during periods of heightened GPR. Further, the findings remain robust to the alternative proxies of GPR and default risk, the instrumental variables method (2SLS), and several additional macro-level control variables. The path analysis technique shows that GPR reduces cash reserves and increases the cost of debt, which exacerbates the risk of default. Additionally, the negative effect of GPR on default risk is more pronounced for firms with a high degree of internationalisation (DOI) and high levels of political risk. Moreover, GPR influences default risk differently depending on the industry. Finally, the study shows that an increase in default risk during times of high GPR results in a decrease in firm value. These findings have implications for investors, creditors, and regulators that should not only help them make informed investment and underwriting decisions but also formulate better policies.Prior to default being a risk, it is crucial for firms to have access to various sources of financing, as this provides the capital required for smooth daily operations, fostering growth, and achieving strategic goals. Such financing can help firms expand into new markets, invest in innovation, and maintain liquidity amid economic volatility. Motivated by the significance of financing to firms, especially those experiencing external uncertainty, the second essay explores the impact of GPR on firms’ informal financing decisions. This essay is set in an international context spanning the period 2000 to 2022. Using the substitution hypothesis and the economic model of trade credit as conceptual frameworks, this study documents that heightened GPR is associated with an increase in firms’ access to informal financing, accompanied by a decrease in the supply of informal financing. Moreover, firms are net receivers of informal financing amidst heightened GPR. These core findings persist even after employing instrumental variable, controlling for other external uncertainties, using alternative proxies for informal financing decisions, applying a one-year lag to GPR, and analysing a reduced sample. Further, the nature of a firm’s goods, the financing frictions, relationship-specific investments, internationalisation and a country’s creditor rights protection, financial openness, and financial development levels all play a significant role in both the access and supply of informal financing during times of rising GPR. However, being a net receiver during heightened GPR remains independent of firm-specific and country-level characteristics. These findings offer implications for corporate management, investors, and creditors, as they offer more context on the dynamics of informal financing strategies in response to fluctuations in GPR.The discussion now turns towards an important issue for firm stakeholders – environmental impact. Contemporary stakeholders are increasingly focusing their investments on eco-friendly initiatives. Hence, there is a rising demand for firms to demonstrate responsibility by strengthening their commitment to addressing climate change. Inspired by these concerns and how firms can contribute to reducing environmental harm, the third essay examines the effect of geopolitical uncertainty on eco-friendly initiatives by corporations. Using a large dataset from 42 countries comprising 37,720 firm-year observations for the period 2002 to 2022, the analysis shows that eco-innovation significantly decreases with heightened GPR. However, this association is mediated by green R&D investment and cash flow volatility. This finding is robust when using alternative measures for GPR (i.e., global GPR and lagged GPR), when using a divided sample for the analysis (i.e., high, and low GPR), and when using series of approaches to control for potential endogeneity problems (i.e., instrumental variable, propensity score matching, and entropy balancing). Further, board independence, gender diversity, the sustainable development levels of the country and the country’s culture of eco-innovation significantly mitigate the adverse impacts of GPR on eco-innovation. All these findings advance the debate on how firms are helping to manage the environmental impacts of their operations during times of uncertainty.