Eugenio Rojas

Firm Heterogeneity & the Transmission of Financial Shocks During the European Debt Crisis

This paper studies the role of firm heterogeneity in the transmission of financial shocks to the real economy. The recent European debt crisis provides a natural experiment with abundant firm-level data on an episode of heterogeneous firm responses to a severe tightening of credit conditions. The data show evidence indicating that smaller firms adjusted more their balance sheets than large firms, and performed better in economies with a more skewed firm size distribution. There is also some evidence suggesting that smaller firms faced larger increases in borrowing costs. This paper proposes a model of heterogeneous firms, in terms of productivity, capital and debt that face financial frictions (defaultable debt and costly equity issuance), a financial intermediation sector, and a sovereign. Financial frictions generate financing structures that depend on firm size, where small firms rely more on equity than debt, which is relatively more costly. Sufficiently large increases in public debt trigger a binding lending constraint for the intermediaries that cause a crowding out of private lending and leads smaller firms to adjust more than large firms. Moreover, firm heterogeneity has aggregate effects that result in larger output declines. Quantitative results show that the model, calibrated to match Spanish firm-level data, is consistent with the empirical facts and explains roughly 50% of Spain's output drop during the crisis.

Download Paper