Zombies at Large? Corporate Debt Overhang and the Macroeconomy

Abstract

With business leverage at record levels, the effects of corporate debt overhang on growth and investment have become a prominent concern. In this paper, we study the effects of corporate debt overhang based on long-run cross-country data covering the near universe modern business cycles. We show that business credit booms typically do not leave a lasting imprint on the macroeconomy. Quantile local projections indicate that business credit booms do not affect the economy’s tail risks either. Yet in line with theory, we find that the economic costs of corporate debt booms rise when inefficient debt restructuring and liquidation impede the resolution of corporate financial distress and make it more likely that corporate zombies creep along.

Corporate debt booms, financial constraints and the investment nexus

“…Fourth, using quantile panel regressions (Machado and Santos Silva 2019, Jordà et al 2020, Adrian et al 2021, I find that corporate debt booms affect more the left tail of the investment growth distribution. This suggests that debt booms amplify downside risks to the real economy (Aikman et al 2019, Adrian et al 2021.…”

“…This paper contributes to the literature on debt cycles and economic activity by revisiting the corporate debt-investment nexus in a large quarterly panel of US firms from Compustat. This paper is closest in spirit to Mian et al (2017), , and Jordà et al (2020), who study how corporate debt overhangs in the corporate sector transmit to the real economy. Using a concept of a debt boom or debt build-ups at the firm level, my main finding suggests that corporate debt overhang is associated with weaker future investment growth over the medium term.…”

“…But two recent papers make the case that only debt booms in household debt are associated with lower medium-term growth, while fluctuations in debt in the non-financial corporate (NFC) sector are not (Mian et al 2017, Jordà et al 2020. They measure debt overhang as long changes in the debt-to-GDP ratio, and use cross-country aggregate data for several advanced economies.…”

“…They measure debt overhang as long changes in the debt-to-GDP ratio, and use cross-country aggregate data for several advanced economies. Jordà et al (2020) suggest that the unique feature and incentives of corporate debt imply that debt of firms in financial distress can normally be restructured and liquidated quickly, unlike household debt, therefore having minimal or no impact on medium-run GDP growth. These findings speak to an earlier literature on the finance-growth nexus, whereby credit deepening and the quality of financial intermediation create the conditions for faster investment and economic growth (King and Levine 1993, Levine 2005, Rancière et al 2008, Beck et al 2012.…”

“…First, I use micro-level data for a large panel of listed US non-financial firms to account for the substantial firm heterogeneity in corporate balance sheets. Studies that use cross-country aggregate data may mask important relationships between debt overhang and investment (Beck et al 2012, Mian et al 2017, Jordà et al 2020. Not accounting for firm heterogeneity may potentially bias the coefficients towards zero as the micro effects are washed away.…”