Debt overhang in a business cycle model

Occhino, Filippo; Pescatori, Andrea

doi:10.1016/j.euroecorev.2014.11.003

Cited by 33 publications

(14 citation statements)

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“…Working-capital management theory implies that firm managers look for target levels of working capital, and that these target levels of working capital would push managers to achieve certain firm size, growth prospects, and debt levels (Aktas et al, 2015;Baños-Caballero, Garcia-Teruel, & Martinez-Solano, 2014;Bentzen, Madsen, & Smith, 2012;Occhino & Pescatori, 2015). Conversely, increasing debt levels could increase the financial stress on companies from higher interest payments (Cai & Zhang, 2011).…”

Section: Review Of Working-capital Literaturementioning

confidence: 99%

The Impact of Working Capital Components on Firm Value in US Firms

Cumbie¹,

Donnellan²

2017

IJEF

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Working capital is an important part of any businesses day-to-day operations. However, most businesses do not take into consideration that continuous investment into working capital does not maximize firm value. The specific problem addressed was firm managers that do not understand the optimal level for each component of working capital create sub-optimal value firm; leading to diminished investment returns for shareholders. For this study, 140 firms for the years 2003-2012 were selected from a stratified random sample of firms listed on the Russell 2000 index. Accounts receivable days outstanding, accounts payable days outstanding, and inventory days outstanding were regressed on economic value to determine whether a curvilinear relationship existed. All three models showed a statistically significant relationship to firm value, F(6, 2268), p<.01, R2= .40, F(6, 2268), p<.01, R2= .38, F(6, 2268), p<.01, R2= .39. Recommendations for firm managers included lowering accounts receivable, accounts payable, and inventory days during boom economic times while increasing accounts receivable, accounts payable, and inventory days during recessionary economic times. Consideration for future research into working-capital management and firm value should consider whether different curvilinear relationships exist between firm value and working-capital components during different economic cycles.

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Section: Review Of Working-capital Literaturementioning

confidence: 99%

The Impact of Working Capital Components on Firm Value in US Firms

Cumbie¹,

Donnellan²

2017

IJEF

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“…In the Merton (1974) approach investment and hirings are not contractible, with moral hazard issues arising as a consequence. For earlier papers introducing Merton-like debt overhang in a macroenvironment see Jakucionyte and van Wijnbergen (2017) and for a similar earlier example Occhino and Pescatori (2015). Indebted rms face lower incentives to invest and hire labor when unanticipated net resource outows have led to a stock of arrears on existing debt with prior claim on any new cashows, a situation for which Myers (1977) coined the phrase debt overhang.…”

Section: Related Literaturementioning

confidence: 99%

“…Our modeling framework follows Merton (1974) who introduced the concept of debt overhang in corporate nance; see Occhino and Pescatori (2015) and Jakucionyte and van Wijnbergen (2017) for similar applications of the Merton approach in a business cycle model. Similarly to Jakucionyte and van Wijnbergen (2017) and in contrast to Occhino and Pescatori (2015), we allow the volume of corporate loans to vary over time rather than assume a xed loan size. Financially constrained rms live for two periods.…”

Section: Financially Constrained Rmsmentioning

confidence: 99%

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Unclogging the Credit Channel: On the Macroeconomics of Banking Frictions

Jakucionyte

Wijnbergen

2018

SSRN Journal

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We explore the consequences of dierent nancial frictions on the corporate and banking level for macroeconomic policy responsiveness to major policy measures. We show that both corporate and bank debt overhang reduce the eectiveness of scal policy: multipliers turn negative with debt overhang in either sector. The negative impact of banking frictions on macro outcomes increases when a larger part of working capital is nanced through credit in addition to investment. Debt overhang in banks leads to positive NPV loans being rejected; but after banks increase their equity ratio and subsequently engage less in risk shifting behavior, a decline in lending emerges. Thus the macroeconomic response to higher capital requirements depends on which friction is dominant: when there is debt overhang in banks higher capital leads to more, not less loans and is expansionary; while higher capital requirements lower loan volumes and have a recessionary impact when risk shifting is the problem in banks.We trace the dierential importance of corporate versus banking debt overhang back to the dierent approaches followed on each side of the Atlantic in response to the undercapitalization of the banks after the onset of the nancial crisis. We similarly trace macrodevelopment dierences in the Southern periphery of Europe and the Northern European countries to dierences in the problems and policies in their nancial sector.Key Words: Banking frictions, Fiscal Policy, Capital Requirements, volatility Shocks JEL Codes: E44, E58, E62, G18, G21 * We are indebted to Frederic Malherbe and Christian Stoltenberg for helpful discussions and to Peter van Els and other seminar participants at DNB for comments. We are indebted to DNB for nancial support for this research. The views expressed here do not represent the views of DNB.

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“…In the rest of the paper, Section 2 describes the eurozone crisis events and the ECB's policy response; Section 3 introduces the model and de-2 In addition, there is a growing literature that explores the aggregate implications of debt overhang on business investment, and includes Lamont (1995), Philippon (2009), Occhino and Pescatori (2014, 2015, Arellano, Bai and Kehoe (2012), Gomes, Jermann and Schmid (2013), and Kobayashi and Nakajima (2014).…”

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The 2012 Eurozone Crisis and the ECB's OMT Program: A Debt-Overhang Banking and Sovereign Crisis Interpretation

Occhino

2015

Working Paper (Federal Reserve Bank of Cleveland)

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The 2012 Eurozone Crisis and the ECB's OMT Program: A Debt-Overhang Banking and Sovereign Crisis InterpretationFilippo OcchinoThis paper develops a model to interpret the 2012 eurozone crisis and the ECB's policy response. In the model, bank lending is distorted by debt overhang, banks hold sovereign bonds, and the government guarantees the bailout of bank creditors. A self-fulfi lling pessimistic view of the economy can trigger a banking and sovereign crisis: with pessimistic economic expectations, the value of sovereign bonds declines, the bank risk of default rises, and the debt overhang distortion worsens; this leads to a contraction in bank lending and to a decline in economic activity, which confi rms the initial pessimistic expectations. A commitment by the central bank to purchase the sovereign bonds at pre-crisis market spreads manages to eliminate the crisis equilibrium.

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Debt overhang in a business cycle model

Cited by 33 publications

References 33 publications

The Impact of Working Capital Components on Firm Value in US Firms

The Impact of Working Capital Components on Firm Value in US Firms

Unclogging the Credit Channel: On the Macroeconomics of Banking Frictions

The 2012 Eurozone Crisis and the ECB's OMT Program: A Debt-Overhang Banking and Sovereign Crisis Interpretation

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