The Aggregate Consequences of Default Risk: Evidence from Firm-Level Data (with Tim Besley and John Van Reenen)
Abstract: This paper studies the implications of perceived default risk for aggregate output and productivity. Using a model of credit contracts with moral hazard, we show that a firm’s probability of default is a sufficient statistic for capital allocation. The theoretical framework suggests an aggregate measure of the impact of credit market frictions based on firm-level probabilities of default which can be applied using data on firm-level employment and default risk. We obtain direct estimates of firm-level default probabilities using Standard and Poor’s PD Model to capture the expectations that lenders were forming based on their historical information sets. We implement the method on the UK, an economy that was strongly exposed to the global financial crisis and where we can match default probabilities to administrative data on the population of 1.5 million firms per year. As expected, we find a strong correlation between default risk and a firm’s future performance. We estimate that credit frictions (i) cause an output loss of around 28% per year on average; (ii) are much larger for firms with under 250 employees and (iii) that losses are overwhelmingly due to a lower overall capital stock rather than a misallocation of credit across firms with heterogeneous productivity. Further, we find that these losses accounted for over half of the productivity fall between 2008 and 2009, and persisted for smaller (although not larger) firms.
Bank Default Risk Propagation along Supply Chains: Evidence from the U.K. (with Mariana Spatareanu, Vlad Manole, and Ali Kabiri)
Abstract: How does banks’ default risk affect the probability of default of non-financial businesses? The literature has addressed this question by focusing on the direct effects on the banks’ corporate customers –demonstrating the existence of bank-induced increases in firms’ probabilities of default. However, it fails to consider the indirect effects through the interfirm transmission of default risk along supply chains. Supply chain relationships have been shown to be a powerful channel for default risk contagion. Therefore, the literature might severely underestimatethe overallimpactof bank shockson default risk in the businesseconomy. Our paper fills this gap by analyzing the direct as well as the indirect impact of banks’ default risk on firms’ default risk in the U.K. Relying on Input-Output tables, we devise methods that enable us to examine this question in the absence of microeconomicdata on supply chain links. To capture all potentialpropagation channels, we account for horizontal linkages between the firm and its competitors in the same industry, and for vertical linkages, bothbetween the firm and its suppliers in upstream industries and between the firm and its customers in downstream industries. In addition, we identify trade credit and contract specificity as significant characteristics of supply chains, which can either amplify or dampen the propagation of default risk. Our results show thatthe banking crisis of 2007-2008 affected the non-financial business sector well beyond the direct impact of banks’ default risk on their corporate clients.
Gravity in international finance: Evidence from fees on equity transactions (with Luke Milsom, Vladimir Pazitka, and Dariusz Wojcik)
Abstract: We shed light on the impact of institutional quality and information barriers on trade in financial services using a novel panel data set on revenue earned on domestic and cross-border equity securities underwriting transactions. Our data set covers 91,511 transactions across 122 countries of origin and 145 countries of destination for the period 2000-2015. The granularity of our data set enables us to estimate theory-consistent gravity equations, avoiding the methodological caveats that apply to most of the existing literature on gravity in international finance. First, we find that institutional quality in the exporting country, proxied by the rule of law, is an important determinant of financial services trade. In addition, we provide support for the “bonding hypothesis” (Coffee, 1999) in the literature on the d eterminants of foreign listings. Foreign firms can increase their valuation by bonding themselves to high-quality institutions through cross-listing. In line with this hypothesis, we find that institutional quality matters primarily for transactions where the underwriter is located in the country of the stock exchange where the shares are listed. Second, we focus on the role of multinational business networks in breaking down information frictions. Specifically, we control for several measures of “connectivity” based on banks’ parent-subsidiary networks and syndication ties across banks. We find evidence supporting our hypothesis. In all our estimations, we control for the classical determinants of trade in the gravity framework, including distance. Interestingly, we find that the inclusion of our institutional and informational variables leaves a very limited role for physical distance - supporting the consensus in the literature on gravity in international finance that the role of distance reflects institutional and information frictions.
Leverage and productivity growth in emerging economies: Is there a threshold effect? (with Fabrizio Coricelli, Nigel Driffield, and Sarmistha Pal)
Also circulated as Microeconomic implications of credit booms: evidence from emerging Europe, EBRD Working Paper No. 119
Published as: When does leverage hurt productivity growth? A firm-level analysis in Journal of International Money and Finance, 2012, vol. 31, pp.1674–1694
When does leverage hurt productivity growth? A firm-level analysis (with Fabrizio Coricelli, Nigel Driffield, and Sarmistha Pal), Journal of International Money and Finance, 2012, vol. 31, pp.1674–1694
Abstract: In the wake of the global financial crisis, several macroeconomic contributions have highlighted the risks of excessive credit expansion. In particular, too much finance can have a negative impact on growth. We examine the microeconomic foundations of this argument, positing a non-monotonic relationship between leverage and firm-level productivity growth in the spirit of the trade-off theory of capital structure. A threshold regression model estimated on a sample of Central and Eastern European countries confirms that TFP growth increases with leverage until the latter reaches a critical threshold beyond which leverage lowers TFP growth. This estimate can provide guidance to firms and policy makers on identifying “excessive” leverage. We find similar non-monotonic relationships between leverage and proxies for firm value. Our results are a first step in bridging the gap between the literature on optimal capital structure and the wider macro literature on the finance-growth nexus.
Work in progress
Managing for a Rainy Day? Precautionary Savings and Managerial Quality
Draft coming soon
The aggregate consequences of credit misallocation in Japan (with Yukiko Saito and Philip Schnattinger)
Draft coming soon
Minimum wages and the China Syndrome: Causal evidence from U.S. local labor markets (with Luke Milsom)
Draft coming soon