Economic Policy Uncertainty and Corporate Cash Hoarding: A Threshold Analysis of U.S. State-Level Data

Economic policy uncertainty (EPU) refers to the inability to predict future government policy actions, ranging from shifts in fiscal and monetary policy to changes in trade regulation. EPU adds risk to long-term planning for investments such as R&D and capital expansion. Existing research shows that higher levels of EPU reduce firm investment and increase precautionary cash holdings (Duong, Huu Nhan, et al. 2020). Firms in areas with strong institutional quality are less affected by the negative effects of EPU (Farooq, Umar, Mosab I. Tabash, et al. 2022). Although previous literature suggests that the relationship between uncertainty and firm behavior is linear, this research theorizes that there may be a tipping point that causes firms to switch from investing to hoarding cash. This hypothesis is rooted in real options theory and precautionary savings theory. Under uncertainty, the value of waiting increases, and with more downside risk, there is a greater need for liquidity. Therefore, my thesis aims to find the specific level of U.S-state economic policy uncertainty that causes firms to shift from investing to hoarding, and analyze how this threshold varies across different levels of institutional quality. Reductions in investment and shifts toward cash hoarding during high EPU periods can lessen productivity, slow employment, and alter leverage decisions, ultimately slowing broader economic growth. If investment behavior is non-linear, then a slight increase in uncertainty may have no effect until a certain tipping point. Identifying these specific EPU thresholds allows policymakers to better predict economic slowdowns and evaluate how state-level institutional quality acts as a stabilizer. Accordingly, since state-level variation creates different reactions to EPU, the thresholds across states might differ, allowing for the implication of inequality in institutional design. If a firm reduces investment once a threshold is crossed, will persistent high levels of EPU cause GDP to tank? Conversely, if stronger institutional quality raises the level of uncertainty firms can tolerate, is state governance quality an economic stabilizer? Thus, I expect to find that higher institutional quality allows firms to withstand greater policy uncertainty before hitting a tipping point in their investment behavior. These findings would imply that, by strengthening local institutional quality, macroeconomic damage caused by high levels of EPU would be mitigated.