Macroeconomic fluctuations and corporate financial fragility

Using a large sample of accounting data for non-financial companies in France, this paper studies the interactions between macroeconomic shocks and companies’ financial fragility. We consider links in both directions, namely whether firms’ bankruptcies are affected by macroeconomic variables, and whether bankruptcies determine the business cycle. We estimate forecasting equations for firms’ bankruptcy using Shumway's (2001) approach and study the joint dynamics of bankruptcies and macroeconomic variables within an exogenous VAR type model estimated at the sector level. We find evidence of reciprocal links between the bankruptcy rate and the output gap and highlight significant “second round effects” of shocks to the output gap on bankruptcies. We show how taking into account the dynamic transmission of macroeconomic shocks matters in stress testing exercises.

► It provides evidence of “second round effects” between macroeconomic cycles and changes in financial fragility, as measured at the microeconomic level by corporate bankruptcies.
► The estimation uses the FIBEN database, a very rich accounting database on individual firms in France.
► It is based on the estimation at the sector level of a two equation VAR-type system: the first one explains firms’ bankruptcies by financial ratios and macroeconomic variables; the second one the output gap by firms’ bankruptcies. Additional macro variables can also be used.
► Given the statistically and economically significant effect of bankruptcies on the output gap, “second round effects” appear quite clearly.
► The paper also identifies a few trade-offs associated with the approach, regarding endogenous defaults, the use of accounting data, the relevance of financial market variables, the identification assumptions in VAR models.