Exploring the Heterogenous Effect of Political Risk on Corporate Investment in Emerging Markets

Abstract

Emerging markets are increasingly important in the global economy but remain vulnerable to political shocks and instability. This study examines how political risk affects corporate investment in emerging markets, accounting for both country-and firm-level heterogeneity. The dataset covers firms listed in 21 emerging markets from 2001 to 2021. The analysis uses a two-way fixed effects panel regression model, complemented by subsample analyses to identify heterogeneous effects. The findings indicate that the effects of political risk vary across subsamples characterized by high and low political risk. Firm-level characteristics such as industry affiliation, cash holdings, asset tangibility, and financial flexibility contribute to these heterogeneous effects. Capital-intensive firms are more exposed to political risk; high asset tangibility amplifies negative effects, while greater cash holdings mitigate them. The study also presents notable findings on key variables in investment theory based on countries’ political risk levels. For example, the Tobin’s Q ratio, which reflects growth opportunities, has a higher coefficient in low-risk countries. Cash flow sensitivity is lower in these countries, while financial leverage is statistically significant only in high-risk countries. Overall, the study underscores the importance of a stable political environment in emerging markets and recommends that firms carefully manage financial policies, particularly cash holdings, investment irreversibility, and capital budgeting decisions to mitigate the adverse effects of political risk. © 2025, National Research University Higher School of Economics (HSE University). All rights reserved.