Hit by multiple shocks, the corporate sector has increased its debt over recent years. The European Central Bank (ECB) Blog shows that strained balance sheets could significantly depress firms’ investment in the coming years with negative implications for innovation and growth.
A strong corporate sector is crucial for investment, innovation and eventually economic growth. Currently, the lingering COVID-19 pandemic, the Russian war of aggression against Ukraine and elevated energy prices stress the financial resilience of companies. Firms also remain challenged by the need to finance large-scale green investments. By comparison to larger firms, small and medium-sized enterprises (SMEs) have been particularly affected as they have lower equity. All of this drives corporate indebtedness. Against this backdrop we discuss the implications for corporate investment and answer the following questions in this post: Does high corporate debt act as a drag on investment following economic crises? Is investment by smaller firms more affected than that by larger firms? And when comparing euro area regions, are there differences in the impact on investment of a change in debt?
Negative impact of high corporate debt on investment
A negative link between high debt and investment is well established with several channels at work. High corporate indebtedness implies higher interest expenses and thus less money available for investment. Firms with high debt also find it harder to obtain new funds from external sources due to their higher default risk. Moreover, the desire to repair weak balance sheets leads firms to reduce their debt burden, and thereby forgo investment opportunities.
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