The Impact of Geoeconomic Fragmentation on Corporate Financial Performance

In recent years, there has been a significant increase in what is known as geoeconomic fragmentation across the world. This phenomenon, marked by major geopolitical changes, has raised serious concerns about its effects on economic and financial connections between countries and companies. From the Brexit to trade disputes between major economies and geopolitical conflicts globally, the global landscape has been undergoing a noticeable transformation.

While the analysis of geoeconomic fragmentation has primarily focused on its impact on international trade and global value chains, there has been limited exploration of its financial impacts on firms. Most studies have concentrated on cross-border capital flows, asset prices, and overall risk aversion in the market. However, a recent study by D’Orazio, Fabrizio, and Gazzani (2024) sheds light on the financial impacts of geoeconomic fragmentation from a firm-level perspective.

The study introduces a new firm-level measure of exposure to geopolitical risk, combining detailed information on the geographic distribution of corporate revenues with country-specific assessments of geopolitical risk to create a revenue-weighted geopolitical risk indicator. By analysing a large sample of non-financial corporations from the Eurostoxx 600 and the S&P500 equity indexes, the study uncovers significant findings regarding the impact of geopolitical risk on firms’ financial performance.

The authors propose a revenue-weighted measure of firms’ exposure to geopolitical risk, based on the geographical breakdown of corporate revenues and country-specific assessments of geopolitical risk. The findings indicate that firms’ revenue exposure to markets characterised by high geopolitical risk has a substantial impact on corporate viability and is also reflected in lower investors’ valuations.

The study reveals that a one standard deviation increase in the revenue-weighted geopolitical risk measure results in a notable increase in corporate viability (measured by the Altman Z-score), the price-to-earnings (P/E) ratio, and the Tobin’s Q ratio. These findings highlight the significant influence of geopolitical risk on firms’ financial performance, particularly in recent years, amid escalating tensions and increased protectionist rhetoric.

One important point to consider is that these results are based on revenue geographical breakdown pertaining to the sale of final goods and services and do not account for other forms of cross-country linkages, such as intermediate output trades. Nonetheless, the study provides valuable insights into the financial implications of geoeconomic fragmentation for firms and the potential amplification of macro-financial turbulence in the future.

In conclusion, the study underscores the importance of accurate microdata in measuring the real-financial interdependencies of geoeconomic fragmentation. As global tensions continue to evolve, the financial consequences for firms may intensify, with possible cross-border effects, including capital shifts away from exposed firms, reduced asset valuations, and heightened market volatility.

Overall, the findings of this study contribute to a deeper understanding of the impact of geoeconomic fragmentation on firms’ financial performance and call for further research to assess the evolving landscape of geopolitical risk and its implications for corporate viability and market valuations.