Do geopolitical risks increase corporate risk‐taking?—Based on the perspective of diversification expansion

• Published date: 01 May 2024
• Author: Li Li,Xiang Cheng
• Date: 01 May 2024
• DOI: http://doi.org/10.1111/corg.12538

ORIGINAL ARTICLE

Do geopolitical risks increase corporate risk-taking?—Based on

the perspective of diversification expansion

Li Li

1

| Xiang Cheng

2

1

School of Economics, Sichuan University,

Chengdu, Sichuan, China

2

School of International Studies, Sichuan

University, Chengdu, Sichuan, China

Correspondence

Xiang Cheng, School of International Studies,

Sichuan University, Chengdu, Sichuan 610064,

China.

Email: chengxiang_scu@163.com

Funding information

This research was funded by the China

Postdoctoral Science Foundation

(2022M712282) for Xiang Cheng.

Abstract

Research Question/Issue: Does geopolitical risk increase a firm's risk-taking, and will

diversification expansion smooth out or exacerbate this effect?

Research Findings/Insights: Based on microdata of Chinese A-share listed compa-

nies, we find that (1) geopolitical risk significantly increases corporate risk-taking at

both micro and macro levels; (2) horizontal diversification can significantly smooth

out the impact of geopolitical risk on a firm's risk-taking, while vertical diversification

will exacerbate the effect; (3) geopolitical risk and diversification do not significantly

impact all firms, and their effect are limited to non-state-owned enterprises and firms

in manufacturing industries.

Theoretical/Academic Implications: First, compared with the previous studies, this

paper identifies the geopolitical risk faced by each sample firm separately, thus pro-

viding a more accurate analysis of the impact of the specific geopolitical risk faced by

the firm on its risk-taking. Second, we expand the connotation of diversification and

analyze its moderating effect on corporate risk-taking from the perspective of hori-

zontal and vertical diversification. Third, considering that the degree of political affili-

ation and capital intensity may affect a firm's sensitivity to geopolitical risk, this paper

examines the relationship between geopolitical risk, diversification, and a firm's risk-

taking regarding property rights and industry type.

Practitioner/Policy Implications: On the one hand, export-oriented firms should pay

close attention to the geopolitical risk situation in exporting countries to reduce the

adverse impact of sudden geopolitical risks. On the other hand, diversification expan-

sion is a double-edged sword for firms. Although vertical diversification increases the

risk-taking of a firm, it also increases its specialization. Therefore, it is necessary to

make a comprehensive judgment on whether and what kind of diversification an

enterprise should undertake according to its business development status.

KEYWORDS

corporate governance, corporate risk-taking, diversification, geopolitical risk

1|INTRODUCTION

In recent decades, significant global events like the 2015 European

migrant crisis, Sino-US trade conflicts, and Russo-Ukrainian conflicts

have had a profound impact on the world's geopolitical landscape.

As a result, the economic and political arenas have undergone rapid

evolution and adjustment. Caldara and Iacoviello (2022) define geopo-

litical risk as any threat, realization, or escalation of adverse events

relating to war, terrorism, or tension between states or polities that

impact the peace process in international relations. Figure 1illustrates

Received: 7 September 2022 Revised: 21 March 2023 Accepted: 10 May 2023

DOI: 10.1111/corg.12538

428 © 2023 John Wiley & Sons Ltd. Corp Govern Int Rev. 2024;32:428–448.wileyonlinelibrary.com/journal/corg

the geopolitical risk index (GPR) for major countries between 1985

and 2022. Notably, GPR varies significantly across countries, with

some, like the United States and the United Kingdom, regularly facing

high geopolitical risk and others, like Japan and Germany, facing low

geopolitical risk over time. Furthermore, some countries, such as

China, have historically experienced low geopolitical risk but recently

encountered a sharp increase in risks.

Geopolitical tensions are spilling over into all aspects of the eco-

nomic sphere, and geopolitical risks have become significant to the

economic outlook (International Monetary Fund, 2017). From a macro

perspective, many scholars argue that geopolitical risks may hurt the

national economy. These effects are manifested not only in the esca-

lation of geopolitical risks that will exacerbate the volatility of essen-

tial asset variables in financial markets and affect international capital

flows (Apergis et al., 2018; Balcilar et al., 2018; Bouri et al., 2019) but

also in the negative impact of geopolitical shocks from political risk on

macroeconomic and business cycles, hindering economic recovery

(Caldara & Iacoviello, 2022; Cheng & Chiu, 2018). In addition to this,

geopolitical events and threats can impact macroeconomic variables

through several channels (Caldara & Iacoviello, 2022). For example,

the effects of geopolitical risks on oil price volatility (Liu et al., 2019;

Monge et al., 2023; Nonejad, 2022; Smales, 2021), energy security

(Gong et al., 2022; Wang et al., 2021), the financial market and finan-

cial stability (Baur & Smales, 2020; Phan et al., 2022; Y. Tang

et al., 2023; D. Zhang et al., 2023), tourism (Hailemariam &

Ivanovski, 2021; Lee, Olasehinde-Williams, & Akadiri, 2021), defense

expenditures (Khan et al., 2022), international trade (Glick &

Taylor, 2010; International Monetary Fund, 2017), actual output

(Lee & Lee, 2020), and so forth.

Meanwhile, at the micro level, geopolitical risk can also have a sig-

nificant impact on firm's behavioral decisions. For example, Jia et al.

(2022) argue that geopolitical risk is significantly and positively related

to firm innovation and that ownership, government subsidies, over-

seas operations, and product market competition shape the relation-

ship between GPR and firm innovation. Le and Tran (2021) argue that

geopolitical risk significantly reduces a firm's foreign investment and

that this effect varies significantly across countries. In addition, sev-

eral studies have examined the impact of geopolitical risk on firms'

cash holdings (Cho, 2023; Lee & Wang, 2021), mergers and acquisi-

tions (Shen et al., 2021), and so forth.

The existing micro-level studies may have some drawbacks. Most

of the studies focus on the behavioral decision-making of firms, and

few have analyzed the impact of geopolitical risk from the perspective

of corporate risk-taking. Corporate risk-taking has long been a topic

of great interest and is fundamental to firm performance and survival

(K. Li et al., 2013). A large number of studies have shown that corpo-

rate risk-taking has a significant positive impact on long-term eco-

nomic growth (Acemoglu & Zilibotti, 1997; John et al., 2008). In turn,

sustained growth leads to higher economic development and better

economic welfare. Thus, understanding the determinants of risk-

taking can help determine future policy directions. More importantly,

existing studies tend to treat the geopolitical risk faced by all firms as

homogeneous, but given that different firms face different major mar-

kets, their exposure to geopolitical risk should also differ, so conclu-

sions based on this assumption may be somewhat biased.

Based on this, this paper analyses the impact of geopolitical risk

on corporate risk-taking using microdata of Chinese A-share listed

companies. Meanwhile, considering the impact of diversification

FIGURE 1 Time trends of the GPR in key

countries. Source: Data were downloaded from

https://www.matteoiacoviello.com/gpr.htm on

May 30, 2022. [Colour figure can be viewed at

wileyonlinelibrary.com]

LI and CHENG 429