Firm Quality Dynamics and the Slippery Slope of Credit Intervention

92 Pages Posted: 1 Dec 2020 Last revised: 6 Nov 2021

See all articles by Wenhao Li

Wenhao Li

University of Southern California - Marshall School of Business

Ye Li

Ohio State University (OSU)

Date Written: November 1, 2021

Abstract

In crises, low-quality firms face greater financial shortfalls and invest less than high-quality firms. Public liquidity support preserves the overall production capacity but dampens the cleansing effects of crises on firm quality. The trade-off between quantity and quality determines the optimal size of intervention. Policy distortions are self-perpetuating: A downward bias in quality necessitates interventions of greater scales in future crises. Distortions are amplified by low-quality firms’ expectations of liquidity support and overinvestment pre-crisis. Finally, the optimal intervention is larger and distortionary effects stronger in a low interest rate environment where low yields on precautionary savings discourage firms from self-insurance.

Keywords: heterogeneous firms, firm distribution, credit intervention, liquidity facility, unconventional monetary policy, collateral, limited commitment, corporate liquidity management, disaster, financial crises, Covid-19 pandemic

JEL Classification: E0, G0

Suggested Citation

Li, Wenhao and Li, Ye, Firm Quality Dynamics and the Slippery Slope of Credit Intervention (November 1, 2021). USC Marshall School of Business Research Paper, Fisher College of Business Working Paper No. 2020-03-028, Charles A. Dice Working Paper No. 2020-28, Available at SSRN: https://ssrn.com/abstract=3737511 or http://dx.doi.org/10.2139/ssrn.3737511

Wenhao Li

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA California 90089
United States

HOME PAGE: http://www.wenhao-li.com

Ye Li (Contact Author)

Ohio State University (OSU) ( email )

Blankenship Hall-2010
901 Woody Hayes Drive
Columbus, OH OH 43210
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
139
Abstract Views
919
rank
263,776
PlumX Metrics