Firm-level Political Risk and Distance-to-default

This study provides the first empirical evidence of the relationship between firm-level political risk and distance-to-default. Based on our examination of a quarterly dataset of 2,727 U.S. firms covering from January 2002 to April 2019, we conclude that firm-level political risk is negatively associated with distance-to-default. We document three mechanisms through which political risk increases default risk: information asymmetry, organizational capital, and investment growth. The evidence indicates that the association is more pronounced for firms with low analysts’ forecast accuracy, organizational capital, and investment growth. By using hand-collected data, we also reveal that firms are able to exploit their corporate lobbying to immunize themselves against default risk. Our findings are robust to different endogeneity identifications, including a natural experiment, alternative distance-to-default proxies, and different sub-samples. Overall, we present novel evidence of an adverse impact of firm-level political risk on distance-to-default and how such negative effect can be mitigated.