In addition to idiosyncratic factors, the likelihood of firms to survive or to fail in a competitive environment is largely governed by macroeconomic risks, with estimates of their impact on the variation of business activities ranging from 25% (Sharpe, 1981) to 75% (Schankerman, 2002). In this paper we use data on 20 administrative regions over the period 1985-2002 to empirically assess the nature and properties of the nexus between business failures and macroeconomic shocks in Italy.
In particular, we employ panel cointegration techniques to disentangle the short and long run co-movements between sources of systematic (i.e., non-diversifiable) risks for business units and corporate failure rates. This allows us to directly test two competing theories of the interaction between the business cycle and productivity growth.
A large body of literature has highlighted that adverse macroeconomic conditions significantly affect companies' profitability and gearing, forcing financially fragile firms to fail (Ballantine et al., 1993; Machin and Van-Reenen, 1993; Geroski et al., 1997). Therefore, in the short-run bankruptcies are unambiguously countercyclical, as recessions create financial distress by narrowing the margin between cash flow and debt service. From a theoretical viewpoint, however, the systemic long-run outcome following from temporary aggregate shocks causing a bunch of concurrent bankruptcies is undetermined.
On the one hand, the bankruptcy of a company can be good news for survivors due to reduced competition (Iqbal, 2002). Moreover, the opportunity cost (OC) theory of productivity growth suggests that transitory aggregate disturbances may have long-run positive effects on economic growth, as activities aimed at improving productivity have a comparative advantage during recessions (Caballero and Hammour, 1994; Aghion and Saint-Paul, 1998). If we interpret the number of business liquidations as a manifest expression of economy-wide efforts to perform resource reallocation, the OC theory has immediate testable implications as regards the relationship between business failure rates and economic activity.