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The aggregate consequences of default risk: evidence from firm-level data

Besley, Timothy, Roland, Isabelle and Van Reenen, John (2020) The aggregate consequences of default risk: evidence from firm-level data. CEP Discussion Papers (1672). Centre for Economic Performance, LSE, London, UK.

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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 firmlevel 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.

Item Type: Monograph (Discussion Paper)
Official URL: https://cep.lse.ac.uk/_new/publications/discussion...
Additional Information: © 2020 The Authors
Divisions: Economics
Centre for Economic Performance
Subjects: H Social Sciences > HC Economic History and Conditions
H Social Sciences > HD Industries. Land use. Labor
H Social Sciences > HG Finance
JEL classification: D - Microeconomics > D2 - Production and Organizations > D24 - Production; Cost; Capital and Total Factor Productivity; Capacity
E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations; Cycles
L - Industrial Organization > L1 - Market Structure, Firm Strategy, and Market Performance > L11 - Production, Pricing, and Market Structure; Size Distribution of Firms
O - Economic Development, Technological Change, and Growth > O4 - Economic Growth and Aggregate Productivity > O47 - Measurement of Economic Growth; Aggregate Productivity; Cross-Country Output (Income) Convergence
Date Deposited: 11 Jan 2021 14:15
Last Modified: 12 Feb 2021 00:24
URI: http://eprints.lse.ac.uk/id/eprint/108227

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