Firm fragility

Abstract

This chapter investigates the issue of firm-level fragility in the context of the current pandemic. The existing (mostly macro-financial) literature limits the discussion to firm-level financials based on balance sheet fundamentals, such as equity or liquidity ratios. We highlight the fact that fragility can be driven by forces beyond the control of a single firm embedded in a supply network with limited bargaining power. The explanatory power of these financial ratios is limited, as they cannot explain the channel through which fragility evolves for a firm. Our theoretical model uses stylized facts from the pandemic to discuss the possibility of unintended exit (due to fragility) as well as business opportunities that can emerge as a unified framework. We examine the behavior of the supply network subjected to a coordinated supply shock like Covid-19 at the boundary conditions and demonstrate that ex ante non-fragile firms (based on balance sheet fundamentals) can become fragile due to network-driven inter-firm linkages. We dwell on the challenges of empirical evaluation of fragility in a supply network context in the passing, along with policy-relevant factors for addressing unintended firm exit.