Is Corporate Indebtedness a Drag on Investment after Financial Shocks?

Abstract

Using novel firm-level data covering the universe of all incorporated manufacturing firms in Türkiye, this paper examines whether elevated corporate indebtedness holds back investment in the aftermath of a large financial shock, such as the one experienced in Türkiye in 2018. The results of the difference in differences model reveal that high-indebted firms reduce their investments significantly compared to low-indebted firms. This suggests that high debt remaining on corporate balance sheets seems to become a substantial impediment to investment. Accordingly, loans are found to be decreasing with leverage. The results also show that the detrimental impact of high financial leverage seems to be valid only for SMEs but not for large firms. Moreover, the effect is more pronounced for non-exporters and young firms, and firms with high cash holdings could attenuate the adverse impact of high indebtedness.

JEL Codes: C23, D22, E22, G31, G32
Keywords: Corporate debt; Financial shocks; Firm investment; Debt overhang; Corporate cash policy