Real effects of financial distress: the role of heterogeneity

Staff working papers set out research in progress by our staff, with the aim of encouraging comments and debate.
Published on 02 August 2019

Staff Working Paper No. 814

By Francisco Buera and Sudipto Karmakar

What are the heterogeneous effects of financial shocks on firms’ behavior? This paper evaluates and answers this question from both an empirical and a theoretical perspective. Using micro data from Portugal during the sovereign debt crisis, starting in 2010, we document that highly leveraged firms and firms that had a larger share of short-term debt on their balance sheets contracted more in the aftermath of a financial shock. We use a standard model to analyse the conditions under which leverage and debt maturity determine the sensitivity of firms’ investment decisions to financial shocks. We show that the presence of long-term investment projects and frictions to the issuance of long-term debt are needed for the model to rationalize the empirical findings. We conclude that the differential responses of firms to a financial shock do not provide unambiguous information to identify these shocks. Rather, we argue that this information should be used to test for the relevance of important model assumptions.

PDFReal effects of financial distress: 
the role of heterogeneity



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