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

Abstract

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.

Financial Flexibility and Investment Ability Across the Euro Area and the UK

“…Further, Amadeus removes a firm after at least five years of no reporting data. To eliminate this potential survivorship bias, we compile our database by collecting accounting information from each annual release retrospectively so that we can have the complete history of data for all firms across the entire sample period, similar to previous studies using this database (e.g., Kalemli‐Ozcan et al ., ).…”

Corporate debt and investment: A firm-level analysis for stressed euro area countries

“…We use both net and gross investment since they capture different dimensions of the debt-investment nexus. Net investment (defined as the annual percentage change in tangible fixed assets) is more relevant from a policy point of view given its close link to an economy's level of productivity (Kalemli-Özcan et al, 2015a). Gross investment (net investment plus depreciation) has a stronger theoretical motivation since financial constraints should affect both investment that replaces depreciated assets and new investment (Ferrando et al, 2017).…”

“…A number of empirical studies find evidence that high corporate leverage can have negative effects on investment (Vermeulen, 2002;Benito and Hernando, 2007;Martinez-Carrascal and Ferrando, 2008;Pal and Ferrando, 2010;Kalemli-Özcan et al, 2015a;Barbiero et al, 2016).…”

“…In addition, we follow Bick (2010) and Kremer et al (2013) in including a regime-specific intercept term (δ 1 ). 9 We assume the errors ε it to be independent and identically distributed 10 and lag all right-hand-side variables by one 8 See Kalemli-Özcan et al (2015a), Goretti andSouto (2013), or Coricelli et al (2012) for a discussion of firm-level control variables usually used in investment and productivity regression models.…”

“…Many economists have thus pointed out that corporate indebtedness in euro area countries inhibits investment spending and economic recovery whenever debt levels are "excessively" high (see e.g. Cecchetti et al, 2011;ECB, 2013;Kalemli-Özcan et al, 2015a).…”