Debt Overhang in a Business Cycle Model

Occhino, Filippo; Pescatori, Andrea

doi:10.26509/frbc-wp-201003r

Cited by 16 publications

(16 citation statements)

References 3 publications

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“…Because the marginal benefit of any new investment is reaped by the firm’s creditors, new junior debtors do not obtain adequate payments from the earnings of any new projects. This lowers the marginal return that the firm expects to receive from any new investment and reduces its incentive to invest, leading to a sub-optimal investment level (Occhino and Pescatori, 2015). If the debt overhang problem is severe for small businesses, the performance of highly leveraged small businesses becomes lower on average.…”

Section: A Literature Review and Hypothesesmentioning

confidence: 99%

High leverage and variance of SMEs performance

Mazen

2019

JRF

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Purpose The purpose of this paper is to examine the relationship between leverage and firm performance using small business data from France by estimating the effects of leverage on both average firm performance and the variance of firm performance. Design/methodology/approach Focusing on French small- and medium-sized enterprises (SMEs), which tend to be dependent on bank loans, the authors examine the relationship between leverage and firm performance. This study was based on a unique panel data set of more than 2,157 manufacturing SMEs covering the years 2007-2015. The authors estimate the effects of leverage on both average firm performance and the variance of firm performance. Findings Focusing on the average effects of leverage, the authors find that highly leveraged firms suffer from poor performance. In addition, the variance in firm performance is higher if firms are highly leveraged. Results also underline that leveraged firms are better performers when they have sufficient collateral assets. Research limitations/implications The study, however, has also some limitations. The first one is that the findings were obtained for only one industry sector, so attempts should be made to study the issue, as it applies to other sectors as well. Second is the context where the study was conducted. This study has been conducted based on data gathered from SMEs in France within a specific socioeconomic context (2007-2008 global financial crisis), which may also limit the generalizability of the results for different contexts with different socioeconomic situations. It would also be useful, to have a better explanation for the performance of SMEs, to add to the model more financial variables or other types of variables such as those related to managerial skills or to the macro-economic environment. Finally, further research could examine the joint impact of both leverage and ownership structure on firm’s performance as a large number of French firms are family firms. The limitations of this study, however, can in fact be an opportunity for future researchers to conduct studies addressing those limitations. Practical implications This research has some implications for small business lending. SME owners and managers may, on the one hand, be encouraged by the fact that collateral assets can reduce agency costs, thereby positively affecting firm performance. On the other hand, high leverage can facilitate firm growth if firms have collateral assets. This implies that policymakers interested in stimulating SMEs should develop more suitable collaterals for high-risk SMEs with low asset tangibility. Social implications The results also have implications for financial institutions. To prevent unexpected and extensive bankruptcies, banks might classify firms with negative cash flows as borrower in danger of bankruptcy. However, the results show that highly leveraged firms with good investment opportunities and high collateral assets reduce the probability of bankruptcy. This implies that banks need to evaluate the credit risk of very highly leveraged small businesses more carefully. Originality/value It should be noted that the case of France remains marginal in terms of the conducted studies.

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Section: A Literature Review and Hypothesesmentioning

confidence: 99%

High leverage and variance of SMEs performance

Mazen

2019

JRF

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“…Hennessy (2004),Titman and Tsyplakov (2007),Moyen (2007),Diamond and Rajan (2011), andOcchino and Pescatori (2015).…”

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confidence: 99%

Debt Overhang, Rollover Risk, and Corporate Investment: Evidence from the European Crisis

Kalemli‐Özcan¹,

Laeven²,

Moreno³

2018

116

100

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We quantify the role of financial leverage behind the sluggish post-crisis investment performance of European firms. We use a cross-country firm-bank matched database to identify separate roles for firm leverage, bank balance sheet weaknesses arising from sovereign risk, and aggregate demand conditions. We find that firms with higher debt levels reduce their investment more after the crisis. This negative effect is stronger for firms holding short-term debt in countries with sovereign stress, consistent with rollover risk being an important channel influencing investment. The negative effect of firm leverage on investment is persistent for several years after the shock in the countries with sovereign stress. The corporate leverage channel can explain 40 percent of the cumulative decline in aggregate investment over four years after the crisis.

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“…Krugman () and Sachs () study debt overhang in the context of public finance. Finally, Lamont (), Occhino and Pescatori (), Phillipon (), and Phillipon and Schnabl () incorporate debt overhang as a friction in macroeconomic models.…”

mentioning

confidence: 99%

Mortgage Debt Overhang: Reduced Investment by Homeowners at Risk of Default

Melzer

2017

The Journal of Finance

134

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Homeowners at risk of default face a debt overhang that reduces their incentive to invest in their property: in expectation, some value created by investments in the property will go to the lender. This agency conflict affects housing investments. Homeowners at risk of default cut back substantially on home improvements and mortgage principal payments, even when they appear financially unconstrained. Meanwhile, they do not reduce spending on assets that they may retain in default, including home appliances, furniture, and vehicles. These findings highlight an important financial friction that has stifled housing investment since the Great Recession.

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Debt Overhang in a Business Cycle Model

Cited by 16 publications

References 3 publications

High leverage and variance of SMEs performance

High leverage and variance of SMEs performance

Debt Overhang, Rollover Risk, and Corporate Investment: Evidence from the European Crisis

Mortgage Debt Overhang: Reduced Investment by Homeowners at Risk of Default

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