Leverage Shocks: Firm-Level Evidence on Debt Overhang and Investment

IMF Working Papers, December 18, 2020

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The global economy is experiencing an unprecedented slump caused by the coronavirus pandemic, occurring at a time of record-breaking debt levels among nonfinancial firms.
Using data on more than 2.8 million nonfinancial firms from 52 countries during the period 1997–2018, the study develops a two-pronged approach to investigate the relationship between corporate leverage and fixed investment spending.
The empirical analysis is robust to a battery of sensitivity checks and confirms corporate leverage is highly vulnerable to disruptions in profitability and cash flow at the firm level and economic growth at the aggregate level.
The findings imply that corporate debt overhang could become a strenuous burden on nonfinancial firms, especially if the COVID-19 pandemic lingers and the global downturn becomes protracted.

Sample: more than 2.8 million nonfinancial firms.
Coverage: 52 countries.
Period: 1997–2018.
Approach: two-pronged empirical strategy (details of the two prongs are described in the source document).

Corporate leverage is highly vulnerable to:
- Disruptions in profitability at the firm level.
- Disruptions in cash flow at the firm level.
- Economic growth slowdowns at the aggregate level.
Robustness: Results hold across a battery of sensitivity checks.

Corporate debt overhang poses a material risk to nonfinancial firms’ investment prospects.
This risk is heightened if the COVID-19 pandemic persists and the global downturn becomes protracted, potentially deepening macro-financial instability and causing long-lasting damage to economic potential.