The Visible Hand when Revenues Stop: Evidence from Loan and Stock Markets during COVID-19
63 Pages Posted: 24 Nov 2020 Last revised: 12 Apr 2021
Date Written: April 9, 2021
We document that public interventions in the corporate sector during the COVID-19 pandemic help firms access bank loans, cushion liquidity shortfalls, and boost their market valuations. We use firm-level data on COVID-19-related news to trace firms’ liquidity shocks in several European countries, which differ in public spending for fiscal stimulus and debt guarantees to corporations. As market valuations rebound in spite of the deterioration of firms’ revenues, interventions drive a part of the disconnect between markets and the real economy. Remarkably, the financial sector internalizes part of the benefits of interventions targeting non-financial firms. To interpret these results, we lay out a moral hazard model of corporate borrowing and public interventions. The model suggests that interventions in the corporate sector are effective to mitigate incentive problems leading to credit market failures. Lenders benefit from loan guarantees as a compensation to finance firms with severe debt overhang problems.
Keywords: corporate debt, debt overhang, guarantees, market failure, public interventions, market value
JEL Classification: G01, G32, G38, H81
Suggested Citation: Suggested Citation