The COVID-19 Impact on Corporate Leverage and Financial Fragility

Sharjil Haque and Richard Varghese

No 2021/265, IMF Working Papers from International Monetary Fund

Abstract: We study the impact of the COVID-19 recession on capital structure of publicly listed U.S. firms. Our estimates suggest leverage (Net Debt/Asset) decreased by 5.3 percentage points from the pre-shock mean of 19.6 percent, while debt maturity increased moderately. This de-leveraging effect is stronger for firms exposed to significant rollover risk, while firms whose businesses were most vulnerable to social distancing did not reduce leverage. We rationalize our evidence through a structural model of firm value that shows lower expected growth rate and higher volatility of cash flows following COVID-19 reduced optimal levels of corporate leverage. Model-implied optimal leverage indicates firms which did not de-lever became over-leveraged. We find default probability deteriorates most in large, over-leveraged firms and those that were stressed pre-COVID. Additional stress tests predict value of these firms will be less than one standard deviation away from default if cash flows decline by 20 percent.

Keywords: COVID-19; Corporate Debt; Optimal Capital Structure; Rollover Risk; Distance-To-Default; Default Risk; Stress Tests; over-leveraged firm; default probability; impact of the COVID-19 recession; model-implied optimal leverage; business risk; debt maturity; Asset valuation; Business enterprises; Currencies; Credit risk; Global; asset volatility (search for similar items in EconPapers)
Pages: 51
Date: 2021-11-05
New Economics Papers: this item is included in nep-cfn and nep-rmg
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Citations: View citations in EconPapers (8)

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