Leverage, investment, and recovery from a financial crisis: the role of debt overhang

Andreas Kuchler

Studies in Economics and Finance, 2019, vol. 37, issue 1, 143-159

Abstract: Purpose - Private investment in advanced economies contracted sharply during the downturn that followed the global financial crisis. A substantial debt overhang has been one proposed explanation for this development. This paper evaluates the role of debt overhang for the slow recovery in investment in Denmark, a country in which levels of private debt rapidly increased before the crisis. Design/methodology/approach - Based on firm-level panel data, this paper evaluates the links between debt and investment dynamics for individual firms during the downturn that followed the global financial crisis. Findings - High leverage contributed to a slow recovery in investment during the downturn that followed the financial crisis, in particular for small and medium-sized enterprises. The effect cannot solely be attributed to mean reversion in investment. Research limitations/implications - Results point to the existence of a separate leverage or “balance sheet” channel with implications for macroeconomic volatility and financial stability. Practical implications - Macroprudential or microprudential measures to counteract the build-up of excess leverage during upswings may contribute to reducing macroeconomic volatility and improving financial stability. Originality/value - In contrast to previous studies, the panel dimension of data is used to take mean reversion in investment into account. The large, nationally representative panel data set allows to assess the macroeconomic relevance of the results, as well as enables subsample splits which are used to gain insights into potential mechanisms through which debt overhang impacts investment.

Keywords: Investment; Leverage; Macroeconomic stability (search for similar items in EconPapers)
Date: 2019
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Persistent link: https://EconPapers.repec.org/RePEc:eme:sefpps:sef-04-2019-0158

DOI: 10.1108/SEF-04-2019-0158

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