Accessible Version
Distressed Firms and the Large Effects of Monetary Policy Tightenings, Accessible Data
Figure 1. Share of Distressed Firms
This is a line chart that shows the share of U.S. firms in financial distress and highlights the share during episodes of monetary policy tightening. The x-axis measures time and ranges from years 1976 to 2022. The y-axis measures the share (in percent) of firms in distress. The data are annual. Firms in distress are those whose distance to default is below the 25th percentile of the distribution of distance to default across the sample. Distance to default is computed using Compustat and CRSP data following the Merton distance-to-default model, which takes as inputs the firm’s equity valuation and leverage. The dashed bars indicate periods of monetary policy tightening and the shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research (NBER). The chart shows that the share of distressed firms, which currently stands at around 37%, is significantly higher now than during all previous tightening episodes except 1988-1989 and 1999- 2000, when the share of distressed firms was similar to what it is now.
Note: This chart displays the share of U.S. firms in financial distress. Firms in distress are those whose distance to default is below the 25th percentile of the distribution of distance to default across the sample. Distance to default is computed using Compustat and CRSP data following the Merton distance to default model, which takes as inputs the firm’s equity valuation and leverage. The dashed areas reflect monetary policy tightening cycles and the gray areas reflect NBER recessions. The shaded bars indicate periods of business recession as defined by the National Bureau of Economic Research (NBER): January 1980 to July 1980, July 1981 to November 1982, July 1990 to March 1991, March 2001 to November 2001, December 2007 to June 2009 and February 2020 to April 2020.
Source: Authors' calculations based on S&P Global, Compustat, Wharton Research Data Services, http://wrds.wharton.upenn.edu/; recession dates from National Bureau of Economic Research (2023); Center for Research in Security Prices, Wharton Research Data Services, http://www.whartonwrds.com/datasets/crsp/; FRED, Federal Reserve Bank of St. Louis.
Figure 2. Average Response of Investment and Employment
This is a set of four line charts that show the estimates of the average dynamic response of investment and employment to a one standard deviation surprise policy tightening or easing across all firms in our sample. The x-axis of the charts starts at 1 quarter ends at 12 quarters. The y-axis denotes the cumulative rate of change. The left panels shows that contractionary shocks generate a strong and statistically significant drop in investment and employment: a one standard-deviation surprise increase in interest rates is associated with a cumulative drop in investment of about 2.5 percent of the initial capital stock after 2 years. The right panels report the effect of expansionary shocks and shows that they do not generate a response of investment or employment that is statistically significantly different from 0. Shaded areas represent the 99 percent confidence intervals of the estimates.
Note: The charts display the estimates of the dynamic responses of investment and employment to a one standard deviation monetary policy tightening or easing shock. The left panels show the effect of tightening shocks while the right panels report the effect of easing shocks. The dependent variable is the difference between the log of total real capital in period t+h and period t-1 in the upper panels and the difference between the log of total employment in period t+h and period t-1 in the lower panels. The monetary surprise in quarter t is calculated by adding the monthly monetary policy shocks obtained from Miranda-Agrippino and Ricco (2021). Tightening shocks are positive surprises and easing shocks are negative surprises. We flip the sign of easing shocks, from negative to positive, so that all shocks have positive values. Shaded areas represent the 99 percent confidence intervals of the estimates.
Source: Authors' calculations based on S&P Global, Compustat, Wharton Research Data Services, http://wrds.wharton.upenn.edu/; FRB data.
Figure 3. Investment Response by Distress
This is a set of four line charts that show the estimates of the average dynamic response of investment to a one standard deviation surprise policy tightening across distressed and healthy firms. The x-axis of the charts starts at 1 quarter ends at 12 quarters. The y-axis denotes the cumulative rate of change. The charts show that there is a large difference in the investment response to tighter monetary policy of distressed and healthy firms: distressed firms (Panel B) reduce their investment in response to tighter policy, while healthy firms are unresponsive (Panel A). The bottom panels show, in contrast, that accommodative shocks do not significantly affect the investment of distressed or of healthy firms. A one standard deviation tightening shock is associated with a cumulative drop in investment after two years of approximately 3.7 percent of the initial capital stock for distressed firms, while the effect on the capital stock of healthy firms is statistically and economically negligible, as can be seen in the top left panel. In contrast to tightening shocks, the bottom panels show that the response of investment to easing shocks is not statistically different from zero at conventional significance levels for both distressed and healthy firms. Shaded areas represent the 99 percent confidence intervals of the estimates.
Note: The charts display the estimate of the dynamic response of investment to a one standard deviation monetary policy tightening or easing shock. The upper panels show the effect of tightening shocks while the lower panels report the effect of easing shocks. The dependent variable is the difference between the log of total capital in period t+h and period t-1. The monetary surprise in quarter t is calculated by adding the monthly monetary policy shocks obtained from Miranda-Agrippino and Ricco (2021). Tightening shocks are positive surprises and easing shocks are negative surprises. We flip the sign of easing shocks, from negative to positive, so that all shocks have positive values. Shaded areas represent the 99 percent confidence intervals of the estimates.
Source: Authors' calculations based on S&P Global, Compustat, Wharton Research Data Services, http://wrds.wharton.upenn.edu/; FRB data.
Figure 4. Net Debt Issuance Response by Distress
This is a set of four line charts that show the estimates of the average dynamic response of net debt issuance to a one standard deviation surprise policy tightening across distressed and healthy firms. The x-axis of the charts starts at 1 quarter ends at 12 quarters. The y-axis denotes the cumulative rate of change. Firms in distress reduce their borrowing significantly in response to a surprise tightening of monetary policy, as shown in the top right panel. When the policy stance becomes more contractionary, firms in distress face tighter borrowing constraints and are, therefore, restricted in their ability to keep borrowing. After two years, a one standard deviation tightening shock reduces the debt of firms that are in distress by around 5%, while it reduces the debt of healthy firms by around 2.5%, with the estimate for these firms also being much less precise statistically, as seen in the top left panel. Moreover, the bottom panels show that the responses of the debt of both healthy and distressed firms to easing shocks are not statistically different from zero. If anything, the point estimates suggest that borrowing by distressed firms surprisingly declines after easing shocks. Shaded areas represent the 99 percent confidence intervals of the estimates.
Note: The charts display the estimate of the dynamic response of investment to a one standard deviation monetary policy tightening or easing shock. The upper panels show the effect of tightening shocks while the lower panels report the effect of easing shocks. The dependent variable is the difference between the log of total capital in period t+h and period t-1. The monetary surprise in quarter t is calculated by adding the monthly monetary policy shocks obtained from Miranda-Agrippino and Ricco (2021). Tightening shocks are positive surprises and easing shocks are negative surprises. We flip the sign of easing shocks, from negative to positive, so that all shocks have positive values. Shaded areas represent the 99 percent confidence intervals of the estimates.
Source: Authors' calculations based on S&P Global, Compustat, Wharton Research Data Services, http://wrds.wharton.upenn.edu/; FRB data.
Figure 5. Employment Response by Distress
This is a set of four line charts that show the estimates of the average dynamic response of employment to a one standard deviation surprise policy tightening across distressed and healthy firms. The x-axis of the charts starts at 1 quarter ends at 12 quarters. The y-axis denotes the cumulative rate of change. Employment is unresponsive to accommodative shocks, as shown in the bottom panels. Contractionary shocks significantly reduce employment growth for firms that are in distress, as shown in the top left panel. After two years, employment growth is around 2% lower for firms in response to a contractionary monetary policy shock for distressed firms. In all the remaining panels, the point estimate is close to zero. Shaded areas represent the 99 percent confidence intervals of the estimates.
Note: The charts display the estimate of the dynamic response of employment to a one standard deviation monetary policy tightening or easing shock. The upper panels show the effect of tightening shocks while the lower panels report the effect of easing shocks. The dependent variable is the difference between the log of total employment in period t+h and in period t-1. The monetary surprise in quarter t is calculated by adding the monthly monetary policy shocks obtained from Miranda-Agrippino and Ricco (2021). Tightening shocks are positive surprises and easing shocks are negative surprises. We flip the sign of easing shocks, from negative to positive, so that all shocks have positive values. Shaded areas represent the 99 percent confidence intervals of the estimates.
Source: Authors' calculations based on S&P Global, Compustat, Wharton Research Data Services, http://wrds.wharton.upenn.edu/; FRB data.