Does economic policy uncertainty impact inventories and firm value? Evidence from the US economy

This paper develops an empirical model to explore how EPU impacts inventory levels in U.S. firms and the effect on firm value under high EPU. This is the first paper to investigate the impact of macroeconomic risk measured by the EPU on inventory and firm value. We apply panel data regression methodology to financial data from a COMPUSTAT sample of 330,905 quarterly observations between 2002 and 2023 for U.S.-based firms. We measure firm value using the market-to-book ratio of assets, which enables us to link inventory policy to market valuation directly. We find that with increased EPU, the total inventory levels, raw material, and finished goods inventory increase, while work-in-process (WIP) inventory level decreases. This indicates that during high EPU, firms increase raw material and finished goods inventory to hedge against supply and demand shortages, while streamlining their internal production processes and workflow, which lowers the WIP inventory, achieving higher inventory leanness. Our findings also indicate that inventory levels and firm value follow an inverted U-shaped relationship. A higher inventory level due to EPU is value-enhancing until it reaches a threshold point, beyond which a firm's value decreases.