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Heterogeneous Firms and Credit Risk

Paper Session

Friday, Jan. 4, 2019 8:00 AM - 10:00 AM

Atlanta Marriott Marquis, M302
Hosted By: American Economic Association
  • Chair: Giulio Seccia, Nazarbayev University

Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics

Dean Corbae
,
University of Wisconsin-Madison and NBER
Pablo d'Erasmo
,
Federal Reserve Bank of Philadelphia

Abstract

In this paper, we ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. Using Compustat data, we first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, we then estimate parameters of a firm dynamics model with endogenous entry and exit to include both bankruptcy options in a general equilibrium environment. Finally, we evaluate a bankruptcy policy change recommended by the American Bankruptcy Institute that amounts to a "fresh start" for bankrupt firms. We find that changes to the law can have sizable consequences for borrowing costs and capital structure which via selection affects productivity (allocative efficiency rises by 2:58%) and welfare (rises by 0:54%).

Sovereign Default Risk and Firm Heterogeneity

Cristina Arellano
,
Federal Reserve Bank of Minneapolis and NBER
Yan Bai
,
University of Rochester and NBER
Luigi Bocola
,
Northwestern University and NBER

Abstract

This paper studies the recessionary effects of sovereign default risk using firm-level data and a model of sovereign debt with firm heterogeneity. Our environment features a two-way feedback loop. Low output decreases the tax revenues of the government and raises the risk that it will default on its debt. The associated increase in sovereign interest rate spreads, in turn, raises the interest rates paid by firms, which further depresses their production. Importantly, these effects are not homogeneous across firms, as interest rate hikes have more severe consequences for firms that are in need of borrowing. Our approach consists of using these cross-sectional implications of the model, together with micro data, to measure the effects that sovereign risk has on real economic activity. In an application to Italy, we find that the progressive heightening of sovereign risk during the recent crisis was responsible for 50% of the observed decline in output.

Default Risk and Aggregate Fluctuations in an Economy with Production Heterogeneity

Aubhik Khan
,
Ohio State University
Tatsuro Senga
,
Queen Mary University of London
Julia Thomas
,
Ohio State University

Abstract

We study aggregate fluctuations in an economy where firms have persistent differences in total factor productivities, capital and debt or financial assets. Investment is funded by retained earnings and non-contingent debt. Firms may default upon loans, and this risk leads to a unit cost of borrowing that rises with the level of debt and falls with the value of collateral. On average, larger firms, those with more collateral, have higher levels of investment than smaller firms with less collateral. Since large and small firms draw from the same productivity distribution, this implies an insufficient allocation of capital in small firms and thus reduces aggregate total factor productivity, capital and GDP. We consider business cycles driven by shocks to aggregate total factor productivity and by credit shocks. The latter are financial shocks that worsen firms' cash on hand. In equilibrium, our nonlinear loan rate schedules drive countercyclical default risk and exit. Because a negative productivity shock raises default probabilities, it leads to a modest reduction in the number of firms and a deterioration in the allocation of capital that amplifies the effect of the shock. The recession following a negative credit shock is qualitatively different from that following a productivity shock, and more closely resembles the 2007 U.S. recession in several respects. A rise in default and a substantial fall in entry yield a large decline in the number of firms. Measured TFP falls for several periods, as do employment, investment and GDP, and the ultimate declines in investment and employment are large relative to that in TFP. Moreover, the recovery following a credit shock is gradual given slow recoveries in TFP, aggregate capital, and the measure of firms.

The Role of Trade Credit and Bankruptcy in Business Fluctuations

Xavier Mateos-Planas
,
Queen Mary University of London
Giulio Seccia
,
Nazarbayev University

Abstract

Given the fact that trade credit is the most important source of short-term firms' credit, we build a quantitative general equilibrium heterogeneous firms model to assess the contribution of trade credit delinquency to observed fluctuations in bankruptcies, GDP and employment. In the model, an intermediate good is purchased by final-good producers on trade credit before observing the realisation of their productivity. A bad productivity shock may ex-post induce final-good producers not to pay suppliers or, alternatively, liquidate via bankruptcy. Aggregate delinquency risk is taken into account by input suppliers; the individual liquidation risk is priced in by lenders supplying bank credit. We characterize firm-level patterns of trade credit delinquency, focusing on its association with bankruptcy risk, indebtedness and size within the distribution of firms. The model delivers levels of trade-credit delinquency and bankruptcy comparable with the data. Within an individual firm, delinquency most often precedes, though it is not necessary for, bankruptcy. Delinquency may mitigate bankruptcies as it provides an alternative option for dealing with financial constraints. We use the model to study the response to aggregate shocks.
Discussant(s)
David Benjamin
,
State University of New York-Buffalo
Grey Gordon
,
Federal Reserve Bank of Richmond
Eric Young
,
University of Virginia
Gabriel Mihalache
,
State University of New York-Stony Brook
JEL Classifications
  • E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy
  • G1 - General Financial Markets