How corporate leverage and debt spillovers affect firm performance in CESEE countries

Če koga zanima – moj novi working paper za EBRD o koncentraciji presežnega dolga v državah srednje, vzhodne in južne Evrope in koristih od razdolževanja največjih dolžnikov za ostala podjetja. Spodaj je uvodni povzetek glavnih ugotovitev.

In most countries of central, eastern and south-eastern Europe (CESEE), private growth and investment is still hampered by persistent financial distress in the corporate sector, as underlined in the recent IMF publication Regional Economic Issues (IMF, 2015). The corporate sector in most CESEE countries took on excessive debt before the 2008 crisis, exposing them to the pressure of having to realign their debt levels in the aftermath of the crisis. This resulted in a typical balance sheet recession with simultaneous and painful deleveraging, which not only aggravated the overall economic downturn but also worsened the prospect of economic recovery. The IMF report shows that seven years into the crisis the debt problem in many CESEE countries is still pervasive, mostly because the institutional frameworks required to ensure a timely and smooth deleveraging were lacking or inefficient.

The obvious way to see how unsustainable debt and limited access to credit affect firm performance is to assess the macroeconomic importance of overleveraged firms in terms of employment, sales, investment, exports and so on. This approach, however, underestimates the true impact of overleveraged firms on aggregate performance of the economies. One important aspect that was largely overlooked in the literature when dealing with overall financial distress is the skewed distribution of excessive debt in corporate sectors and its impact on the economy. As shown by Damijan (2014) for Slovenia, and as demonstrated in section 3 of this paper, the 300 most indebted companies in CESEE on average account for two-thirds of the total corporate debt overhang, contribute about one-sixth of aggregate value added, and one-eighth of aggregate employment. Though these figures constitute a non-negligible overall effect of most indebted companies on overall macroeconomic performance, it is also important to consider the potential indirect effects of these large financially distressed companies on upstream and downstream companies in the national value chains. This may considerably alter the overall macroeconomic importance of the top debtor firms and provide some further justification for preferential treatment of the top 30, top 50 or top 100 debtor firms in terms of financial restructuring.

This aspect becomes even more important in view of the recent advances in empirical analysis and theory of firm dynamics. While standard theory assumes balanced economies where all sectors play roughly symmetric roles as input suppliers to others and where all microeconomic fluctuations are averaged out, recent research shows that when sectors and firms are heterogeneous in terms of size, idiosyncratic microeconomic shocks can lead to a larger macroeconomic downturn than what is predicted under assumptions of a normal distribution. There is a fast-growing body of research showing that when the firm size distribution is “fat-tailed” idiosyncratic shocks to large firms contribute more to aggregate fluctuations (see Gabaix, 2011; Acemoglu et al., 2012, 2015; Di Giovanni et al., 2014). Bernanke et al. (1996) highlight the “small shocks, large cycles puzzle” interaction between the input-output structure and the shape of the distribution of microeconomic shocks as an important potential explanation of the aggregate volatility.

Acemoglu et al. (2015) show that the propagation mechanism of microeconomic shocks works through input-output linkages between sectors and firms. In an unbalanced economy, where some sectors and/or companies play a much more important role than others as input suppliers or buyers to the rest of the economy, microeconomic shocks to individual companies or sectors can lead to the emergence of significant macroeconomic fluctuations. In other words, the frequency of large GDP contractions can be highly sensitive to the nature of micro shocks. Damijan et al. (2016) show how a demand shock affecting a large Slovenian company quickly spreads through the network of its suppliers, creating several rounds of first- and second-order adverse effects along the supply chain. Furthermore, Kelly et al. (2013) develop a network model of firm volatility in which larger suppliers have more customers. They show that network effects are essential in explaining the joint evolution of the empirical firm size and firm volatility distributions.

Hence, when a fraction of larger companies in an economy is burdened by excessive debt and facing significant credit constraints and when this period of financial distress is protracted, this may have disproportionately large adverse effects on the whole economy. Depending on their size and intensity of the input-output linkages with the rest of the economy, financially distressed firms pose a potentially significant macroeconomic risk due to their inability to provide services or products to their upstream customers or to meet financial obligations to their downstream suppliers.

Due to the network effects, the occurrence of financially distressed large firms may play a similar role in the propagation of the crisis as systemic banks burdened by the large shares of non-performing loans (NPLs) in their portfolios. It is hence essential to study the network effects of such “systemically important” companies in the economy and to what extent their financial health / distress affects the rest of the economy.

The research in this paper has three main objectives. We aim to:

  • study the extent of corporate sector excess leverage in CESEE economies
  • identify the largest and “systemically important” companies that are most severely burdened by excessive debt
  • analyse their impact on the performance of vertically linked downstream and upstream firms.

The first objective provides an assessment of the extent of corporate sector excess leverage by country. For the second objective we identify groups of the largest companies (from the top 10 to top 300) with regard to their excess leverage, and assess their direct macroeconomic importance in terms of debt, employment, value added and exports. And for the third objective we estimate a debt spillovers model to assess the indirect effects of financial distress on horizontally and vertically linked industries. The model is estimated using firm-level data for five CESEE countries (Bulgaria, Croatia, Hungary, Romania and Serbia) for the period 2005-14. Finally, we use coefficients estimated by the model to simulate indirect impact of reducing the excessive debt held by the 100 and 300 largest debtor firms on sales, employment and investment of vertically linked companies.

These are the major findings of our paper.

  • Corporate sectors in six CESEE countries are burdened with large extent of excessive debt. On average, 29 per cent of firms are characterised by excess leverage (defined as (net debt – EBITDA) > 4). In four countries this ratio of firms with excessive debt leverage is even bigger, ranging between 31 per cent (Montenegro) and 42 per cent (Serbia).
  • Corporate net debt and excessive debt are highly concentrated across CESEE economies. On average across six CESEE countries, the 20 largest debtor companies account for almost 30 per cent of total debt overhang, while the top 100 and top 300 companies account for almost one half and two-thirds of overall excessive debt, respectively. Bulgaria, Hungary and Serbia reveal the largest concentration of excessive debt, with the 10 most indebted companies holding between 30 and 40 per cent of total debt overhang and the 50 most indebted companies holding between 50 and 60 per cent of total corporate excessive debt.
  • On average, the largest 100 financially distressed firms in six CESEE countries account for 8 per cent of total value added and 6 per cent of total employment, while the 300 most indebted firms account for 13 and 16 per cent of overall employment and value added, respectively. To put it differently, 1 in 8 employees and 1 in 6 euros created in the corporate sector are directly affected by the 300 most indebted companies.
  • Estimations of our debt spillovers model show that firms’ own financial distress was largely tolerated before the crisis, that is, it had no significant impact on firm performance, but became severely taxing on firm performance in the post-crisis period when banks tightened credit standards.
  • In addition to this direct effect, firms’ performance is significantly affected by the excessive debt of firms in other horizontally or vertically linked industries. There are substantial negative spillovers from overleveraged companies in the same industry as well as vertical debt spillover effects of the most indebted companies in vertically linked firms.
  • Firms’ performance is more severely affected by the poor financial health of suppliers, rather than customers. Most importantly, these effects are aggravated during the financial crisis and are more severe for small and medium-sized firms.
  • Simulations based on our estimated model show that if debt in the largest 100 debtors of our sample was reduced to acceptable levels in line with the investment grade rating, we would expect an additional indirect boost to sales of vertically linked firms by between 0.5 per cent (Croatia), 1 per cent (Bulgaria, Hungary and Serbia) and 2.5 per cent (Romania). Similarly, deleveraging the 100 most indebted firms would indirectly boost employment of other firms by 0.25 to 3 per cent, and investment by up to 1 per cent.

These results enable us to draw important policy implications regarding the need to design policies that support the repair of private companies’ balance sheets. Institutional reforms focusing on debt resolution frameworks specifically targeting “systemically important” larger debtor companies may provide essential support to faster economic recovery in some of the debt-ridden CESEE countries. Our findings suggest that SMEs will also indirectly benefit by a timely resolution of NPLs of the most extremely leveraged companies.


Celoten working paper je dostopen tukaj.

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