The role of central bank policies in corporate financial decision-making

Abstract

The monetary policies of the central bank are measurable, determinants of corporate financial decisions, such as investment, financing of debt, dividend distributions, share repurchases, and allocation of capital. In this study, the impacts of interest rate policy, quantitative easing, forward guidance and reserve requirements on corporate financial policies are analyzed, focusing on firm size and industry differences. The study uses a mixed-method design, including panel data regression which involves aggregating 485 firms in the S&P 500 between 2008 and 2023, and qualitative analysis comprised of major monetary policy cycles during the Global Financial Crisis, the COVID-19 stimulus period, and the aggressive interest-rate hike periods from 2022 to 2023. Results reveal that the increase in the federal funds rate significantly curtails capital investment (β = −0.312, p < 0.001), debt-to-equity ratios (β = −0.185, p < 0.001) and buyback, and stimulates the retention of cash in the balance sheet. But that doesn't happen when interest rates are low: Lower interest rates encourage borrowing and buying up assets, as well as merger and acquisition activity. The findings in the sense that the smaller firms are more sensitive to policy-rate changes than the larger firms. Indeed, it is found that industry-level differences between firms with different leverage ratios, and those with different dividend policies, exist as well. The analysis also identifies the impact of forward guidance and the other policy tools used on managers' expectations and business planning horizons. The results of the work are an important edge for macrofinancial linkages understanding and also useful for the corporate treasurers, strategic financial managers, investors, policy makers, and corporate governance.