Abstract
We explore the impact of the credit crunch that followed the European debt crisis on the corporate policies of European firms. We show that banks' exposures to impaired sovereign debt and the risk-shifting behavior of undercapitalized banks contributed significantly to the severity of the crisis. In particular, we present firm-level evidence showing that the lending contraction of banks affected by the crisis depressed the investment, job creation, and sales growth of firms affiliated with these banks. Our estimates suggest that the credit crunch explains between one-fifth and one-half of the overall negative real effects suffered by European borrowing firms.
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