Having learned from the financial crisis, policymakers the world over have reacted to the COVID-19 lockdowns by providing a lot of liquidity, in the form of debt, to the business sector. However, the longer it takes to make a full recovery, the greater is the danger that firms may find themselves not just illiquid in the short-run, but insolvent in the long-run. That is, liquidity shortfalls may turn into equity shortfalls. In the paper “The COVID-19 Shock and Equity Shortfall: Firm Level Evidence from Italy,” the authors Elena Carletti, Tommaso Oliviero, Marco Pagano, Loriana Pelizzon, and Marti G. Subrahmanyam quantify the size of the expected equity shortfalls for a sample of almost 81,000 Italian firms. The results are sobering. The authors forecast that COVID-related profit reductions will lead to about 17% of the firms in their sample having negative net worth in a year. These firms employ 8.8% of the workers in the sample. Overall, reductions in equity may amount to 10% of 2018 GDP. Of course, forecasts are necessarily noisy at this stage, and the long-term effects of COVID on the corporate sector will only be known with time. Nevertheless, the results highlight the need for policymakers to support firms through equity injections in addition to liquidity. Given the heterogeneous effect of COVID on different sectors, an important challenge will be determining which firms to support.
Spotlight by Uday Rajan
Photos courtesy of Elena Carletti, Tommaso Oliviero, Marco Pagano, Loriana Pelizzon, and Marti G. Subrahmanyam