Working Paper: CEPR ID: DP10108
Authors: Viral V. Acharya; Tim Eisert; Christian Eufinger; Christian Hirsch
Abstract: In this paper, we explore the impact of the European Sovereign Debt Crisis and the resulting credit crunch on the corporate policies of firms. Existing theory suggests that sovereign crises can affect the real economy in complex ways based on the nature of the interaction between bank and sovereign health. We show that banks' exposures to impaired sovereign debt and risk-shifting behavior of undercapitalized banks are of first-order importance for explaining the negative real effects suffered by European firms, while moral suasion by governments to buy more domestic sovereign debt does not seem to have played a major role. In particular, we present firm-level evidence showing that the lending contraction at banks affected by the crisis depresses the investment, job creation, and sales growth of firms with significant business relationships to these banks. These firms increase their precautionary motives to save cash out of free cash flows and rely more on cash holdings than bank lines of credit for their liquidity management during the crisis, a typical behavior of financially constrained firms. Our estimates suggest that the credit crunch explains between one fifth and one half of the overall negative real effects in the sample.
Keywords: credit contraction; european sovereign debt crisis; financing constraints; real effects
JEL Codes: E44; G01; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| European sovereign debt crisis (H63) | decline in bank lending (G21) |
| decline in bank lending (G21) | severity of economic downturn (F44) |
| decline in bank lending (G21) | increased cash savings of firms (G32) |
| decline in bank lending (G21) | reduced investment of firms (G31) |
| decline in bank lending (G21) | reduced job creation of firms (J23) |
| decline in bank lending (G21) | reduced sales growth of firms (L25) |
| hit on banks' balance sheets (G21) | decline in bank lending (G21) |
| risk-shifting behavior of undercapitalized banks (G21) | decline in bank lending (G21) |
| increased risk of losses on sovereign bondholdings (F34) | risk-shifting behavior of undercapitalized banks (G21) |
| firms with high dependence on GIIPS banks (F65) | behavior typical of financially constrained firms (D22) |
| firms not directly affected by the crisis (F65) | indirect consequences due to relationships with affected banks (F65) |