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

Which firms are more sensitive to an aggregate financial shock? What can be learnt from these heterogeneous responses? We evaluate and answer these questions from both empirical and theoretical perspectives. Using micro data from Portugal during the sovereign debt crisis we find that highly leveraged firms and firms with a larger share of short-term debt on their balance sheets contracted more in the aftermath of the financial shock. We analyse the conditions under which leverage and debt maturity determine the sensitivity of firms’ investment decisions to financial shocks in standard models of investment under financial frictions. In doing so, we extend these models to feature a maturity choice. We show that simple versions of these models are not consistent with the observed heterogeneous responses. The model needs the presence of frictions when issuing long-term debt to rationalise the empirical findings.

This version was updated in October 2021.

PDFReal effects of financial distress: 
the role of heterogeneity