COVID-19 State Aid Leads to Dangerous Backlog of Corporate Insolvencies

In response to the first COVID-19-related lockdown, particularly small and medium-sized enterprises in Germany received easy access to extensive state aid in order to strengthen the liquidity position of cash-strapped firms. For the most part, this was done in a ‘whatever-it-takes’ fashion to rescue as many firms as possible from insolvency. Clearly, it has been necessary to support healthy companies whose financial difficulties have been the result of the pandemic and the associated measures. However, struggling companies whose existence would have been under threat even without the lockdown also received financial aid. Due to the urgency of the measures, they were implemented in an untargeted manner, which – in addition to generating direct costs in the billions – could also have negative consequences for medium-term growth opportunities and productivity development in Germany. As a recent study by ZEW Mannheim shows, the untargeted financial support has contributed to a backlog of corporate insolvencies. In particular, very small, financially weak companies, which under normal economic circumstances would have been highly likely to file for insolvency, were kept alive without the prospect of successful recovery.

The billion-euro aid packages, together with the suspension of the obligation to file for insolvency in the months after the first lockdown, will result in a wave of corporate insolvencies after the end of the pandemic, with negative consequences for the economy as a whole. “Usually, insolvencies lead to employees moving to other, more efficient and creative companies and to capital flowing away from insolvent to economically sound companies. This process strengthens productivity and innovation in the overall economy and reduces the shortage of skilled workers in stable companies,” explains Dr. Georg Licht, head of the ZEW Research Department “Economics of Innovation and Industrial Dynamics”. This process is, however, disrupted if companies that are unable to survive on the market without policy support are saved from bankruptcy.

The ZEW study shows that in the sectors particularly affected by the crisis, fewer than half as many companies filed for bankruptcy as would have been expected on the basis of pre-crisis data. “This difference is particularly pronounced for micro-enterprises with up to ten employees, while it becomes less significant with increasing company size,” explains Georg Licht. The study shows that this group of companies accounts for the vast majority of the backlog of about 25,000 company bankruptcies. Furthermore, the empirical analysis reveals that the insolvency backlog among micro-enterprises can largely be attributed to companies that were already financially weak before the COVID-19 crisis. For companies that had a good pre-crisis credit rating, on the other hand, no backlog has been observed. “Therefore, as the coronavirus crisis continues, policymakers should distribute funds only after careful consideration,” recommends Georg Licht.

The ZEW study compares the creditworthiness of companies in the pre-crisis period July 2017 to December 2019 with the COVID-19 crisis period April to July 2020 using data from the Mannheim Enterprise Panel (MUP) and covering approximately 1.5 million companies. The MUP is based on a cooperation between ZEW and the Verband der Vereine Creditreform, Germany’s largest credit agency, which provides information on the creditworthiness of companies.