The combined effects of economic policy uncertainty and environmental, social, and governance ratings on leverage

Abstract

This paper examines the combined effects of Economic Policy Uncertainty (EPU) and Environmental, Social, and Governance (ESG) ratings on the level of leverage and its speed of adjustment (SOA). We find that both the EPU and ESG ratings are negatively associated with leverage when assessed separately. However, when EPU and ESG ratings are combined, we show that ESG ratings mitigate the detrimental impact of EPU on leverage. Our results also indicate that higher EPU levels force firms to increase their speed of adjustment due to tighter financing requirements, while ESG ratings overcome that issue and enable firms to maintain lower SOA. These results are robust to various robustness checks and are mainly driven by environmental and social factors. Our paper contributes to the growing ESG literature by showing that ESG ratings can alleviate the adverse effects of EPU on leverage and SOA.