Uncertainty, Stock Prices, and Debt Structure
Ali K. Ozdagli and Jianlin Wang
Abstract
Despite the recognized importance of debt structure in transmitting economic shocks, we know little about its role in transmitting uncertainty. We find that bank debt reduces stock price sensitivity to policy uncertainty, unlike non-bank debt. This mitigating effect comes from cash-flow insolvent firms, consistent with the idea that they particularly value renegotiability of bank debt. Using high-frequency methods, we address challenges in identifying policy uncertainty shocks, focusing on the 2018-2019 U.S.-China trade policy uncertainty and on monetary-policy-related uncertainty around FOMC announcements. Our results suggest that bank debt provides insurance and flexibility for shareholders of distressed firms, especially during turbulent times.