The Long-Term Cost of the Financial Crisis

Abstract

The focus of the current credit crisis is on the immediate implications, such as reduced profits and increased unemployment. In contrast, we show that there are worrisome long-term economic consequences of the crisis through its effect on financially constrained firms. Using a survey of over 1,000 CFOs in the United States, Europe and Asia, we show that firms are cutting back or canceling projects that they know add to firm value. The elimination of profitable projects is especially acute for firms that face financial constraints. One of the basic tenets of finance is that projects that enhance firm value should be pursued. Financial constraints potentially prevent the funding of these projects. The current credit crisis is an ideal setting to measure the impact of constraints on value creation. Turning down or canceling profitable projects is a lesser known cost of the current financial crisis. Our evidence suggests that in the scramble for short-term cash flow, firms are sacrificing long-term value. This implies lower future growth opportunities and lower future employment growth.

Keywords: Financial crisis, financing constraints, investment spending, liquidity management, matching estimators

JEL Classification: G31