Economic policy uncertainty and firm performance: an empirical investigation of Indian firms

Purpose This study aims to empirically investigate the impact of economic policy uncertainty (EPU) on the performance of Indian manufacturing firms. Design/methodology/approach The two-step difference generalized method of moments model is used in this investigation to examine the effect of EPU on the performance of Indian manufacturing firms. Findings The current study finds that EPU has a detrimental effect on firm performance depicting that when uncertainty in the economy arises firms halt their investment decisions eventually leading to a decline in firm performance. Therefore, the findings support the real options theory, investment irreversibility theory and trade-off theory. Furthermore, adopting the subsample approach, this study also finds the negative effect of EPU to be significant on the performance of small-sized firms and firms in the initial phase of their life cycle (young firms) as well as large-sized firms and firms at their maturity stage (mature firms). However, the adverse effect of EPU is observed to be relatively more significant on the performance of young firms than it is for mature firms. This paper also performs an interaction analysis and finds that the results remain more or less the same, confirming the validity of the findings. Originality/value With the rise in economic uncertainties across the world, the need to study such uncertainties in the context of firms’ financial performance is imperative. While studies have been conducted for firms in developed economies, only a few have addressed it for emerging economies. More specifically, the literature lacks empirical evidence solely focusing on the EPU and the performance of Indian manufacturing firms. Therefore, this study emphasizes on examining the effect of EPU on the performance of Indian manufacturing firms. The findings reveal that EPU negatively affects firm performance which adds fresh evidence to the existing literature on EPU. In addition, the moderating role of financial constraints (in terms of firm life cycle and size) on the relationship between EPU and firm performance also adds to the existing literature on firms’ financial constraints.