Debt overhang and real firm outcomes

Arsène Buzima Dunia

No 14/2026, IWH Discussion Papers from Halle Institute for Economic Research (IWH)

Abstract: Does debt overhang distort only investment? This paper analyzes the subsequent effects of debt overhang on firm-level outcomes. Using an event study for German firms from 2004 to 2021, we find that, relative to comparable firms in the same industry and year, highly indebted firms do not merely invest less, which is the classic overhang result. They also hire less, and the two margins together translate into slower sales growth. The composition of the adjustment, however, depends on the firm's growth regime. Highly indebted firms that keep expanding slow their hiring but raise capital per worker over the long run, substituting capital for labour along a flatter expansion path. Highly indebted firms that contract shed workers with no offsetting change in capital intensity: they scale down rather than restructure. These patterns hold in normal times as well as in crises and are concentrated among small and medium-sized limited-liability firms. Debt overhang is therefore not a pure investment wedge but a persistent drag on firm scale, whose incidence across inputs is determined by whether the firm is growing or shrinking.

Keywords: capital-labour substitution; debt overhang; employment; firm growth; firm leverage (search for similar items in EconPapers)
JEL-codes: D22 E22 E24 G31 G32 J23 (search for similar items in EconPapers)
Date: 2026
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:iwhdps:344000

DOI: 10.18717/dp7trs-q433

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