Interest-Rates

RISING INTEREST RATES: THE HEIGHTENED THREAT TO FIRMS’ SURVIVAL IN TIMES OF CRISIS

An increase of one percentage point in the interest rate that a firm faces during a financial crisis increases its chances of failure by more than five percentage points. Young firms, firms with high bank dependency and firms that don’t export are particularly vulnerable to changes in their debt-servicing costs.

These are among the findings of research by Alessandra Guariglia, Marina-Eliza Spaliara and Serafeim Tsoukas, presented at the Royal Economic Society’s 2013 annual conference. The study looks at a large data set of mainly private-held firms in the UK tracked over several years.

The authors compare firms’ response to interest rate changes during times of crisis and calm – and across companies to see the effect of different factors on firm survival. They find that a one percentage point increase in the interest burden during a crisis raises the predicted exit probability by around 5.7 percentage points, while the effect is much smaller during tranquil periods.

The threat of firm failure is high on the agenda of policy-makers as it often involves substantial job losses. The authors argue that policy-makers concerned with saving companies and jobs should work to ease access to finance, particularly in times of crisis. They comment:

‘Access to finance matters strongly as a determinant of survival, hence government policies concerned with firm exit need to target financial markets and institutions.

‘Our findings suggest that the increased interest payments that accompanied the 2007-09 financial crisis played a key role in the propagation of the crisis.

‘The implication is that one way for policy-makers to mitigate the effects of financial crises by limiting firm failures would be to make finance cheaper. This would be particularly helpful for the most financially constrained firms.’

More…

The threat of firm exit is high on the agenda of UK policy-makers in the current economic climate. This research examines the way firm-specific interest payments (interest burden) and firm heterogeneity contribute to firms’ survival prospects, paying special attention to the most recent financial crisis.

The authors document a significant effect of changes in the interest burden from debt-servicing on firm survival. The effect is found to be stronger during the recent financial crisis compared with more tranquil periods. In addition, the authors show that changes in the interest burden are more likely to affect financially fragile firms, for whom access to external finance is difficult or particularly expensive.

To reach these conclusions, the authors use a large firm-level panel data set for the UK. The data set is made up mainly of unquoted firms. This characteristic is particularly appealing since these firms are more likely to be adversely affected during bad economic times.

The authors distinguish between the financial crisis periods and a tranquil period to isolate the effect of crisis on firm survival. They also split their sample into firms a priori more and less likely to face financial constraints, to explore the role of firm heterogeneity in determining survival.

The authors find that debt-servicing costs negatively affect firms’ survival prospects. Specifically, a one percentage point increase in interest burden during the crisis raises the predicted exit probability by around 5.7 percentage points, while the effect is much smaller during tranquil periods.

Finally, the authors take into account different characteristics of firms such as exporting activity, bank dependency and track record to explore the importance of firm heterogeneity in determining firm survival. They find that the survival chances of bank dependent, younger and non-exporting firms are affected more severely than other firms by changes in interest payments, especially during the crisis.

Disentangling the effects of interest burden and financial health on survival is not only of academic interest but also highly relevant for policy in particular, but not only, in the current economic climate. Access to finance matters strongly as a determinant of survival, hence government policies concerned with firm exit need to target financial markets and institutions.

The findings in this study suggest that the increased interest payments that accompanied the 2007-09 financial crisis played a key role in the propagation of the crisis. The implication that follows is that one way for policy-makers to mitigate the effects of financial crises by limiting firm failures would be to make finance cheaper. This would be particularly helpful for the most financially constrained British firms.

ENDS


Contact:

Alessandra Guariglia, University of Birmingham (a.guariglia@bham.ac.uk)

Marina-Eliza Spaliara, University of Glasgow (marina.spaliara@glasgow.ac.uk)

Serafeim Tsoukas, University of Glasgow (serafeim.tsoukas@glasgow.ac.uk)

RES media consultant Romesh Vaitilingam:
+44 (0) 7768 661095
romesh@vaitilingam.com
@econromesh

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