Companies that took on more debt in the run-up to the Great Recession later cut employment more sharply, says new research by MIT Sloan’s Xavier Giroud


“Balance sheet health is a big factor in a firm’s ability to weather a storm.”

Cambridge, Mass., May 21, 2015— Companies that loaded up their balance sheets with debt before the Great Recession later cut employment much more severely than those that were less constrained by debt, according to a study* by Xavier Giroud, Professor of Finance at MIT Sloan School of Management.The study, which has been released by the National Bureau of Economic Research, offers new insight into the role that corporate debt played during the Great Recession, which began in 2007 and is widely considered the worst global downturn since World War II.

“Balance sheet health is a big factor in a firm’s ability to weather a storm,” says Giroud. “Highly leveraged companies had no choice but to lay off people when the downturn hit because they had limited financing options.”

Using data on employment at the establishment level from the U.S. Census Bureau, house prices from Zillow, and balance sheet and income statements from public companies (excluding financial companies and utilities), Giroud and his colleague, Holger M. Mueller, at NYU’s Stern School of Business, found that when faced with plunging home values and the collapse in demand, companies with higher levels of indebtedness closed down stores, cut back on investment, and laid off workers.

“By contrast, companies with strong balance sheets were better able to maintain employment during the recession,” says Giroud. “These low-leverage firms increased both their short- and long-term borrowing. After all, they had freed up debt capacity in the run-up.”

Economists have debated the precise role that debt played in the Great Recession. “There is a lot of interest in getting the narrative right,” says Giroud. “Understanding the mechanisms underlying the Great Recession will help policymakers figure out when intervention might be necessary in the future.”

Some argue that the excessive debt consumers accumulated during the boom years—roughly 2002-2006—exacerbated the economic downturn after house prices fell. When the crisis hit, they didn’t have money to spend on new products and services, and they also couldn’t borrow to support consumption as they had in the past.

Giroud and Mueller’s research provides evidence that the large amounts of debt corporations amassed during those years likely had a similar effect. “Up to this point, many economists have focused on household debt as the main culprit,” says Giroud. “It was too easy for people to get mortgages and that led to a housing bubble and later the crash, or so the conventional wisdom goes. But the lesson of our study is that large public companies and the debt they took on were dangerous to the economy as well.”

* Firm Leverage and Unemployment during the Great Recession; by Xavier Giroud, Holger M. Mueller; NBER Working Paper No. 21076; Issued in April 2015

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