Firms' operating leverage and external shocks: does economic policy uncertainty matter?

This paper investigates the association between operating leverage and economic policy uncertainty based on a sample of French listed firms over 2002-2021. We provide robust evidence that firms tend to lower their operating leverage when economic policy uncertainty increases. This result continues to hold after controlling for endogeneity and conducting a series of robustness tests. Based on the real options theory framework, our results imply that, in an uncertain economic environment, firms may be inclined to cancel or defer their risky investment projects to avoid sunk costs. Our cross-sectional tests further demonstrate that the influence of economic policy uncertainty on operating leverage is less prominent in firms with high profitability and investment intensity. These pieces of evidence contribute to the scarce literature on the exogenous determinants of operating leverage and have practical implications for both investors and regulators.