Debt Overhang, Rollover Risk, and Corporate Investment: Evidence from the European Crisis

We quantify the role of financial leverage behind the sluggish post-crisis investment performance of European firms. We use a cross-country firm-bank matched database to identify separate roles for firm leverage, bank balance sheet weaknesses arising from sovereign risk, and aggregate demand conditions. We find that firms entering the crisis with higher debt levels reduce their investment more after the crisis. This negative effect is stronger for firms holding short-term debt in countries whose banks were weak due to sovereign stress, consistent with rollover risk being an important channel influencing investment. The negative effect of firm leverage on investment is also persistent for several years after the shock in the countries with sovereign stress. The corporate leverage channel can explain about 20% of the cumulative decline in aggregate private sector investment over the crisis period.