To What Extent Does the Interest Burden Affect Firm Survival? Evidence from a Panel of UK Firms during the Recent Financial Crisis
| Author | Serafeim Tsoukas,Alessandra Guariglia,Marina‐Eliza Spaliara |
| DOI | http://doi.org/10.1111/obes.12120 |
| Date | 01 August 2016 |
| Published date | 01 August 2016 |
576
©2015 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd.
OXFORD BULLETIN OF ECONOMICSAND STATISTICS, 78, 4 (2016) 0305–9049
doi: 10.1111/obes.12120
To What Extent Does the Interest BurdenAffect Firm
Survival? Evidence from a Panel of UK Firms during
the Recent Financial Crisis*
Alessandra Guariglia†, Marina-Eliza Spaliara‡ and Serafeim
Tsoukas‡
†Department of Economics, University of Birmingham, Edgbaston, Birmingham, B15 2TT,
UK (e-mail: a.guariglia@bham.ac.uk)
‡Department of Economics, Adam Smith Business School, University of Glasgow, Gilbert
Scott Building, Glasgow, G12 8QQ, UK (e-mail: serafeim.tsoukas@glasgow.ac.uk,
marina.spaliara@glasgow.ac.uk)
Abstract
Using a panel of mainly unquoted UK firms over the period 2000–09, we document a
significant effect of changes in the interest burden from debt-servicing on firm survival.
The effect is found to be stronger during the recent financial crisis compared with more
tranquil periods. Furthermore, the survival chances of bank-dependent, younger, and non-
exporting firms are most affected by changes in the interest burden, especially during the
crisis. Our results are robust to using different estimation methods and different interest
burden measures They suggest that one way for policymakers to mitigate the effects of
financial crises by limiting firm failures would be to prevent financing costs from rising,
especially for those firms more likely to face liquidity constraints.
I. Introduction
InAugust 2007, an ir regular pattern of financial difficultiesbecame a fully-fledged financial
crisis involving most of the world’slargest banks (see Goodhart, 2008, for a sur vey).These
events had a strong impact on UK financial markets in general and the banking sector
in particular. Due to the turmoil in financial markets, at the end of the third quarter of
2008, 1.4 million small firms in the UK reported a severe shortage of credit, and some
30% of firms considered shutting down their operations altogether unless credit became
JEL Classification numbers: D21; E22; E32; G31.
*Wethank the Editor and two anonymous referees for very helpful comments and suggestions. Weare also grateful
to Markus Eberhardt, Richard Harris, Kishore Kamath, Stephen Millard, Daphne Nicolitsas, George Panos and Evan
Wohlmann for useful comments, as wellas to par ticipants at seminars at the Bank of England, the Bank of Greece,
the Universities of Glasgow, Leicester, Patras, and Stirling, and at the 2012 European Association for Research
in Industrial Economics meetings, the 2013 European Meetings of the Econometric Society, and the 2013 Royal
Economic Society conference.The first and second authors g ratefullyacknowledge financial support from the British
Academy.Any remaining errors are our own.
Interest burden and firm survival in the UK 577
cheaper and more easily available (Kirkup and Tyler, 2008).1In addition, according to
the Federation of Small Businesses, almost 30,000 small and medium-sized enterprises
(SMEs) failed in 2009, while figures provided by the Office for National Statistics (2010)
show that the corporate death rate in the UK at the end of 2009 was 11.8%. Paying special
attention to England and Wales during the early 1990s recession and the current financial
crisis, Benito et al. (2010) confirm that company liquidations rise during recessionary
periods. This evidence suggests the presence of a strong link between the shortage and
high cost of credit, which typically characterizes recessions, and firm failures.
The purpose of this paper is to further investigate the effects of the recent financial crisis
on firms’ survivalchances. To this end, we focus on the impact of changes in a firm-specific
interest rate (which we call interest burden and define as the ratio of a firm’s total interest
payments to cash flow) on business failures in the UK over the period 2000–09, and assess
whether the strength of this impact increased during the crisis years.
Our study is motivated by the financial accelerator-related hypothesis according to
which deteriorations in economic conditions increase the cost of finance, which in turn
weakens firms’ balance sheet positions, thus influencing their ability to borrow, and, con-
sequently, their activities and survival chances (Bernanke, Gertler and Gilchrist, 1996;
Perez-Quiros and Timmermann, 2000; Vermeulen, 2002). It is well accepted that firms’
interest burden is inversely related to their balance sheet positions.A high interest burden
can in fact be seen as evidence that the firm is charged a high external finance premium.
The countercyclical movement in the premium for external funds amplifies borrowers’
spending and economic activity through the financial accelerator (Bernanke et al., 1996).
Thus, the debt servicing cost is expected to affect firms’ real and financial decisions, as
well as their survival prospects.
The present study makes two important contributions to the literature. First, while pre-
vious papers have included balance sheet variables in equations modelling firm survival
(Bunn and Redwood,2003; Bridges and Guariglia, 2008), the literature is silent on the role
of the firm-specific interest burden in determining firms’ chances of failure. Considering
the evidence according to which higher levels of interest payments negatively affect fixed
investment and employmentdecisions at the firm-level (Nickell and Nicolitsas, 1999; Ben-
ito, 2005; and Benito and Young, 2007), we move this literature forward by investigating,
for the first time, the links between firms’ interest burden and their survival chances. As
firms’ real activities are adversely affected by a rise in borrowing costs, we expect higher
levels of the interest burden to be associated with lower chances of firm survival. Moreover,
we differentiate the effectsof changes in the interest burden on fir m survivalover a tranquil
period (2000–06) and the financial crisis period (2007–09), focusing on the UK, which was
particularly affected by the crisis (Rose and Spiegel, 2011). This may help us understand
the channels through which the financial crisis led to the failure of several UK firms, and
in particular several small and medium-sized enterprises (SMEs).
Our second contribution is that contrary to most of the literature, which looked at the
effects of the financial crisis focusing on listed companies (e.g. Santos, 2011; Kahle and
1Similarly, according to the British Chambers of Commerce (BCC), one-third of small and medium-sized busi-
nesses in the UK faced difficulties in accessing finance during the recent crisis. Even more recently,access to finance
remains a ‘major barrier’ to growthfor more than one in five small companies, with 41% of loan applications refused
in the three months to February 2012 (Kuchler, 2012).
©2015 The Department of Economics, University of Oxford and JohnWiley & Sons Ltd
To continue reading
Request your trial