6. Conclusions
This paper finds evidence that defaults in an industry can have non-negligible negative effects on the real investment decisions of non-distressed peers. Due to this effect, firms which are more constrained (i.e., those firms whose long-term debt largely matures after the demise of a competitor) cut their yearly investment rates by around four percentage points (or 10 percent) more than otherwise similar firms in the same industry that do not need to refinance their debt. The paper shows that these negative effects are temporary, that they exist even in the absence of recessions or industry downturns that coincide with the defaults in the industry, and that their channel of propagation is different from the channel of propagation of industry downturns.
The findings in this paper show that this effect is stronger in the most competitive industries, where firms have little margin to adjust prices to compensate for the lower financing, and where information is more dispersed. Moreover, effects are stronger for smaller and unrated firms, cash-poor firms, highly indebted firms, and firms with reduced debt capacity, and are muted by large and rated firms, cash-rich firms, low leverage firms, and firms with large debt capacity. These findings are consistent with the latter firms failing to reduce their investment levels in spite of the higher financing costs, possibly to maintain their market share, or even to gain a higher future market share. Consistently with this interpretation, the negative effects of financing costs on invested are also muted in markets that are relatively concentrated.
These results imply that, through lower investment, financial distress can impose indirect costs to the real economy, and that the real costs of distress go way beyond first-order effects to the direct firm stakeholders. The results also show that these indirect costs are dampened for firms with strong balance sheets and in markets that are relatively concentrated.
