The COVID-19 Insolvency Gap: First-Round Effects of Policy Responses on SMEs
47 Pages Posted: 18 Mar 2021
Date Written: January 1, 2021
COVID-19 placed a special role to ﬁscal policy in rescuing companies short of liquidity from insolvency. In the ﬁrst months of the crisis, SMEs as the backbone of Europe’s real economy beneﬁted from large and mainly indiscriminate aid measures. Avoiding business failures in a whatever it takes fashion contrasts, however, with the cleansing mechanism of economic crises: a mechanism which forces unviable ﬁrms out of the market, thereby reallocating resources eﬃciently. By focusing on ﬁrms’ pre-crisis ﬁnancial standing, we estimate the extent to which the policy response induced an insolvency gap and analyze whether the gap is characterized by ﬁrms which had already struggled before the pandemic. With the policy measures being focused on smaller ﬁrms, we also examine whether this insolvency gap diﬀers with respect to ﬁrm size. Based on credit rating and insolvency data for the near universe of actively rated German ﬁrms, our results suggest that the policy response to COVID-19 has triggered a backlog of insolvencies in Germany that is particularly pronounced among ﬁnancially weak, small ﬁrms, having potential long term implications on economic recovery.
Keywords: COVID-19 policy response, Corporate bankruptcy, Cleansing eﬀect, SMEs
JEL Classification: C83, G33, H12, O38
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