Stock Returns, Leverage, and the COVID-19 Pandemic

Abstract

This paper investigates how firm debt disproportionately impacted the stock returns of firms who were highly exposed to the economic consequences of social distancing. Specifically, I use a difference-in-difference design to causally identify the impact that higher levels of firm debt had for firms who were more exposed to social distancing requirements. I find that the effects on stock returns are economically meaningful. I also show that both the sign and magnitude of this effect vary as the pandemic unfolds. In the period from February 20, 2020-March 20, 2020, when the stock market was declining significantly, increased debt caused lower stock returns for firms less able to transition their workers to teleworking relative to those who were more able to comply with social distancing. This effect abruptly reverses when the Federal Reserve announces their major intervention into the corporate bond market on March 23, 2020. In the period from March 23, 2020-March 24, 2020 I document that increased debt caused higher stock returns for firms more affected by COVID-19. My results illustrate how real economic shocks interact with firm financial positions and translate into stock market returns. Also, my results highlight how Federal Reserve policy causally impacted stock market returns, giving us a window into the market's perceptions of the Federal Reserve's unprecedented intervention into the corporate bond market.