Abstract
COVID-19 placed a special role on fiscal policy in rescuing companies short of liquidity from insolvency. In the first months of the crisis, SMEs as the backbone of Germany’s economy benefited from large and mainly indiscriminate aid measures. Avoiding business failures in a whatever-it-takes fashion contrasts, however, with the cleansing mechanism of economic crises: a mechanism which forces unviable firms out of the market, thereby reallocating resources efficiently. By focusing on firms’ pre-crisis financial standing, we estimate the extent to which the policy response induced an insolvency gap and analyze whether the gap is characterized by firms which were already struggling before the pandemic. With the policy measures being focused on smaller firms, we also examine whether this insolvency gap differs with respect to firm size. Our results show that the COVID-19 policy response in Germany has triggered a backlog of insolvencies that is particularly pronounced among financially weak, small firms, having potential long-term implications on entrepreneurship and economic recovery.Plain English Summary This study analyzes the extent to which the strong policy support to companies in the early phase of the COVID-19 crisis has prevented a large wave of corporate insolvencies. Using data of about 1.5 million German companies, it is shown that it was mainly smaller firms that experienced strong financial distress and would have gone bankrupt without policy assistance. In times of crises, insolvencies usually allow for a reallocation of employees and capital to more efficient firms. However, the analysis reveals that this ‘cleansing effect’ is hampered in the current crisis as the largely indiscriminate granting of liquidity subsidies and the temporary suspension of the duty to file for insolvency have caused an insolvency gap that is driven by firms which were already in a weak financial position before the crisis. Overall, the insolvency gap is estimated to affect around 25,000 companies, a substantial number compared to the around 16,300 actual insolvencies in 2020. In the ongoing crisis, policy makers should prefer instruments favoring entrepreneurs who respond innovatively to the pandemic instead of prolonging the survival of near-insolvent firms.
Highlights
COVID-19 and its unprecedented economic impacts have ground economies worldwide to a halt
Focusing on Germany, a country where liquidity support for Small and Medium-sized Enterprises (SMEs) has been strong by international standards (Anderson & et al 2020; OECD, 2020a) and been accompanied by a temporary suspension of the obligation to file for insolvency (Federal Ministry of Justice and Consumer Protection, 2020), we identify the insolvency law as an important institutional determinant for entrepreneurship dynamics
We describe the policy instruments to counter the economic impacts of the COVID-19 crisis in more detail, focusing on how the instruments differ with respect to firm size
Summary
COVID-19 and its unprecedented economic impacts have ground economies worldwide to a halt. As a result of the early lockdown measures to contain the spread of the virus, many companies faced reduced business activity and declining sales, which had an immediate impact on their liquidity positions. Both the negative demand shock paired with a negative supply shock in most industries have put numerous companies under severe pressure to keep their operations afloat. As smaller and entrepreneurial companies are characterized by strong dependence on internally generated funds to capitalize their business and provide the liquidity needed to finance day-to-day operations, both their cash reserves and collaterals for external financing are generally limited (Cowling et al, 2020). Trapped in a situation of thin capital reserves and lack of collaterals for drawing new credit lines, small firms face a high risk of business failure without the relief through policy intervention
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