The COVID-19 Impact on Corporate Leverage and Financial Fragility

50 Pages Posted: 22 Jun 2021 Last revised: 16 Sep 2021

See all articles by Sharjil Haque

Sharjil Haque

University of North Carolina at Chapel Hill

Richard Varghese

International Monetary Fund (IMF)

Date Written: March 16, 2021

Abstract

We study the impact of the COVID-19 recession on capital structure of publicly listed U.S. firms. Our estimates suggest leverage (Net Debt/Asset) decreased by 5.3 percentage points from the pre-shock mean of 19.6 percent, while debt maturity increased moderately. This de-leveraging effect is stronger for firms exposed to significant rollover risk, while firms whose businesses were most vulnerable to social distancing did not de-lever relative to less vulnerable companies. We rationalize our evidence through a structural model of firm value that shows lower expected growth rate and higher volatility of cash flows following COVID-19 reduced optimal levels of corporate leverage. Model-implied optimal leverage indicates firms severely affected by lockdowns became over-leveraged. We find default probability deteriorates most in large, over-leveraged firms and those that were stressed pre-COVID. Additional stress tests predict value of these firms will be less than one standard deviation away from default if cash flows decline by 20 percent.

Keywords: COVID-19, Corporate Debt, Optimal Capital Structure, Rollover Risk

JEL Classification: G00, G10, G30, G32, G33

Suggested Citation

Haque, Sharjil and Varghese, Richard, The COVID-19 Impact on Corporate Leverage and Financial Fragility (March 16, 2021). Available at SSRN: https://ssrn.com/abstract=3867371 or http://dx.doi.org/10.2139/ssrn.3867371

Sharjil Haque (Contact Author)

University of North Carolina at Chapel Hill ( email )

Gardner Hall, Department of Economics, UNC - CH
Chapel Hill, NC 27514
United States

Richard Varghese

International Monetary Fund (IMF) ( email )

700 19th Street, N.W.
Washington, DC 20431
United States

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