Scarring and Corporate Debt

IMF Working Papers, October 28, 2022

Source details

Authors: Julia Estefania-Flores, Davide Furceri, Pablo Gonzalez-Dominguez, Siddharth Kothari, Nour Tawk
Published: October 28, 2022
Series: IMF Working Papers
DOI: https://doi.org/10.5089/9798400225703.001

Paper estimates the scarring effect of recessions on corporates’ investment and how it is amplified by the level of corporate debt.
High debt firms see a larger decline in investment than low debt firms.
Back-of-the-envelope calculations suggest that firms’ debt accounts for at least 28 percent of the average medium-term decline of investment following a recession.
Effect is especially larger for firms that are credit constrained—small and less profitable firms, as well as firms with high share of short-term debt—who may find it more difficult to rollover or raise new funds to invest in new projects.
Results are robust to several checks, including to various sub-samples, alternative measures of recessions and explanatory variables, and a large set of controls.

The effect of firms’ debt in shaping the response of investment to recessions is described as both statistically significant and economically sizeable.
High debt firms exhibit a larger decline in investment relative to low debt firms during and after recessions.
Credit constraints amplify scarring: small firms, less profitable firms, and firms with a high share of short-term debt face larger investment declines due to greater rollover and financing difficulties.

Keywords and methods referenced include: Capital spending, Corporate Debt, debt dummy, debt firm, Economic recession, Firms, Global, investment to recession, Local Projection, Recessions, Scarring, scarring effect.
Robustness checks reported include alternative sub-samples, alternative measures of recessions, alternative explanatory variables, and extensive control sets.

Corporate debt levels materially influence post-recession investment scarring, implying policies that affect corporate leverage and access to finance can alter medium-term investment recovery.
Credit access for small, less profitable, and short-term debt–heavy firms is a key channel: measures to ease rollover and new financing for these firms could mitigate scarring.