Governments’ Late Payments and Firms’ Survival: Evidence from the European Union

Abstract

Outstanding payments in commercial transactions, if delayed beyond the agreed period of time, can engender a range of negative externalities and expose firms to severe liquidity risks. In this study we examine to what extent stricter regulations addressing payment backlogs, brought about by the EU directive on late payments, have affected firms’ performance. We focus on government-to-business activities and on the firms’ responses to the introduction of these regulations. Our evidence suggests that firms’ exit rates fall relatively more in sectors that sell a larger fraction of their output to the government. We document more pronounced effects in sectors with a large share of small firms, for countries characterized by longer payment delays, and for countries with high levels of perceived corruption. Taken together, our findings indicate that more discipline in governments’ payment terms can have considerable effects on economic activity.