The Aggregate Consequences of Default Risk: Evidence from Firm-Level Data

78 Pages Posted: 29 Jan 2020

See all articles by Timothy J. Besley

Timothy J. Besley

London School of Economics & Political Science (LSE) - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR)

Isabelle A. Roland

University of Cambridge - Faculty of Economics

John Van Reenen

Massachusetts Institute of Technology (MIT)

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Date Written: January 2020

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 firm-level 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.

Keywords: Credit frictions, Default Risk, Misallocation, productivity

JEL Classification: D24, E32, L11, O47

Suggested Citation

Besley, Timothy J. and Roland, Isabelle A. and Van Reenen, John, The Aggregate Consequences of Default Risk: Evidence from Firm-Level Data (January 2020). CEPR Discussion Paper No. DP14327, Available at SSRN: https://ssrn.com/abstract=3526052

Timothy J. Besley (Contact Author)

London School of Economics & Political Science (LSE) - Department of Economics ( email )

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National Bureau of Economic Research (NBER)

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Centre for Economic Policy Research (CEPR)

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Isabelle A. Roland

University of Cambridge - Faculty of Economics ( email )

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John Van Reenen

Massachusetts Institute of Technology (MIT) ( email )

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Cambridge, MA 02139-4307
United States

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