Abstract
The coronavirus (COVID-19) pandemic has severely affected economic activity around the world. The reduction in business activity during the pandemic will leave many firms highly indebted. Some face long-lasting or even permanent changes to their economic environment, and recovery may take a long time in the most affected industries. As a result, many firms are likely to be insolvent or close to insolvency when the public support measures that are currently in place are withdrawn. This ASC Insight provides an economic perspective on the trade-offs involved in dealing with a potential post-pandemic rise in corporate insolvencies. Based on a brief summary of the economics of insolvency, we argue that the key challenge in dealing with post-pandemic corporate insolvencies will be to distinguish between viable firms and those which, owing to structural changes in their economic environment, have become non-viable “zombie” firms. Targeting of intervention measures is therefore essential. For viable firms, policy should aim to facilitate debt restructuring, relying on formal or informal insolvency procedures. For non-viable firms, policy should seek to facilitate the reallocation of resources to more productive uses. In facilitating efficient restructuring and the reallocation of productive assets, the nature of the COVID-19 shock raises a number of specific issues. - Small firms have been particularly affected by the COVID-19 shock. Yet, formal insolvency procedures often do not deal efficiently with small firms, in particular when it comes to restructuring. - Policy should be mindful of congestion in formal and informal insolvency procedures. This includes the court system, banks’ ability to restructure their loans, as well as labour and asset markets through which resources are being reallocated. Policy should aim to increase capacity. - Given the nature of European capital markets, banks play a central role in the restructuring of corporate debt. Potential regulatory and accounting disincentives to restructuring should be kept low. Restructuring by banks and landlords could be incentivised, for example, via tax credits. - During restructuring, viable firms need access to liquidity. There may be a role for policy to ensure such liquidity provision, particularly outside of formal insolvency procedures (for example, via liquidity facilities directed at banks that restructure loans).