Amid the ongoing financial distress caused by the COVID-19 pandemic, bankruptcies are set to rise dramatically, according to a commentary in Fortune. The business busts will strike small firms disproportionately, which is bad news for more than just the business owners. It’s bad for the whole economy, because the surge of financial pain may overwhelm the bankruptcy system. The worrisome outlook emerges from new research by Robin Greenwood of the Harvard Business School, Benjamin Iverson of Brigham Young University’s Marriott School of Business, and David Thesmar of the MIT Sloan School of Management. Their findings are full of surprises, starting with the reality of bankruptcies in the pandemic so far, according to the commentary. Despite a parade of high-profile chapter 11 filings, especially in retail — J.C. Penney, Neiman Marcus, J. Crew, Brooks Brothers — overall bankruptcies through August were “actually 1% lower than in the same timeframe in 2019,” the authors report. It’s no illusion that big companies were more likely to file during the first eight months of 2020, but small businesses were much less likely to file. Maybe that’s because they still had some Paycheck Protection Program funds. Or maybe, as a Jeffries note to clients hypothesized, it’s because many small businesses were so strapped they couldn’t afford to hire a bankruptcy lawyer. In any case, the researchers argue that the numbers have to rocket. “We expect overall bankruptcies to increase by as much as 140 percent in the current year,” they write. “By all metrics, corporate financial distress is set to increase.” Economists don’t see bankruptcies as necessarily bad. When tough times strike, some businesses inevitably will struggle; the bankruptcy process helps sort out which should be given a second chance and which should be liquidated. The resulting reallocation of capital and labor, painful as it may be, helps to rebuild the economy. The danger in the pandemic crisis is that the process may not work as it should. That’s partly because “the balance sheets of small firms are hit the hardest by the current recession,” the researchers find, which is a problem because “small firms restructure very rarely.” Instead of working things out with their creditors, they mostly just fail. They’re less likely to get a second chance because some of their most valuable assets, such as the entrepreneur’s know-how, can’t be pledged to investors. Read more.
*The views expressed in this commentary are from the author/publication cited, are meant for informative purposes only, and are not an official position of ABI.
