Abstract

This paper investigates empirically the linkages between corporate debt overhang and investment activity at the firm level for a cross section of large-sized emerging market and developing economies. It analyzes the extent to which investment may be discouraged by high levels of debt that put at risk future profits, as well as firm dimensions that may sharpen the debt-investment link. Using balance sheet data from a broad set of emerging market and developing economy firms, the analysis suggests that corporate debt overhang imposes a sizable effect on investment at the firm level. This linkage is more pronounced for large firms and highly leveraged firms. The analysis also finds evidence of a nonlinear effect, in which debt overhang discourages investment more severely under high levels of indebtedness.

Highlights

  • Corporate debt in emerging market and developing economies (EMDEs) has risen substantially over the past decade, encouraged at least in part by the low interest rate, low risk aversion environment that has largely prevailed during this period

  • Corporate debt in EMDEs has risen to unprecedented levels

  • Grounded in the fundamental insights of Myers (1977), the results of this paper suggest that one such vulnerability is weak investment

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Summary

Introduction

Corporate debt in emerging market and developing economies (EMDEs) has risen substantially over the past decade, encouraged at least in part by the low interest rate, low risk aversion environment that has largely prevailed during this period It has, on average, risen from about 60 percent of GDP in 2006 to 86 percent of GDP in 2017. Corporate earnings have been generally declining over the past few years in the context of the economic slowdown in many EMDEs, as GDP growth in EMDEs has declined from 7.3 percent in 2010 to 4.3 percent in 2017 (World Bank 2018) These developments suggest that risks associated with debt overhang conditions may be rising in emerging economies. Debt overhang per se is not necessarily an early warning indicator of a financial crisis It describes conditions under which the burden of debt may cause weak levels of private investment.

Conceptual framework and literature
Empirical methodology and results
Conclusions
Debt to earnings in low and high investment firms
Findings
Leverage
Full Text
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