Industry Shocks, Operating Risk, and Corporate Financial Policies around the World

Although developing economies are more volatile, firms in developed countries hold more cash and less debt. We show that despite greater aggregate and industry stability, the performance and balance sheets of individual firms in developed countries are more volatile. In developing countries, market imperfections insulate incumbent firms from competitive risk. Cross-country differences in firm rivalry and cash flow risk are greater in technology-intensive, external-finance-dependent, and large-firm-dominated industries where we expect greater market imperfections. Firms in developed countries are more sensitive to shocks. Most of the adjustments come from cash balance. We propose product market competition as a new channel in which market imperfections can drive the international difference in financial policies.