Heterogeneous effect of economic policy uncertainty and firm financial performance: Empirical evidence from India

Abstract Globally, high levels of economic policy uncertainty (EPU) have revamped the debate about its impact on different economic parameters of firms. In this regard, the literature exhibits three gaps. First, the effect of EPU on firm financial performance in an emerging economy context. Second, whether the influence of EPU on firm performance is asymmetric? Lastly, the moderating role of leverage in the relationship between EPU and firm performance. This paper fills all three gaps using the real options theory and investment irreversibility theory for India's NIFTY 100 firms over the period 2010–2019. The study applies several panel data econometrics models suitable to obtain comprehensive and robust results. Specifically, findings from the two‐step system GMM confirm that EPU negatively influences financial performance, which is significant for both accounting (return on assets, return on equity, net profit margin) and market (Tobin's Q) based measures. Moreover, the results of panel quantile regression reveal considerable heterogeneity in the EPU‐financial performance relationship. Further, higher levels of EPU appear to have unfavorable effects on excessively indebted firms. Overall, the study recommends that governments need to be alerted to the fact that mitigating EPU is crucial for promoting sustainable firm financial performance.