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Economics March 19, 2020

How to help the right firms when (all) firms struggle

By Maximilian A. Müller
stack of money and chart
With whole economies shutting down, policymakers around the world deliberate how to keep “healthy” businesses that temporarily struggle alive.

My research together with Inga Bethmann and Martin Jacob informs this debate by looking at how governments support struggling businesses – those that make losses – through tax benefits on a regular basis. Our findings indicate that providing liquidity irrespective of firms’ prospects helps primarily “unhealthy” firms since, in normal times, capital providers do a fairly good job in helping “healthy” firms through a temporary setback. Therefore, measures that help capital providers handle the currently unusually high uncertainty about whether and when “healthy” firms will be “healthy” again are likely more effective than allocating capital directly.

In some countries, loss firms can reduce their tax payments in the future when they make profits again. Other countries (incl. Germany) are less restrictive and provide loss firms with a refund of their past tax payments. The research compares how loss firms fare under these two systems. Essentially, one system helps loss firms if they have a healthy future, the other helps loss firms if they had a healthy past. Our research shows that loss firms invest more under the latter system that grants direct cash injections. It also finds, however, that especially “unhealthy” loss firms use tax refunds to fund their investment. Such “unhealthy” loss firms also survive longer in the product markets (which could hurt consumers, ultimately).

One interpretation of these findings is that a system granting subsidies to struggling businesses without checking for their future prospects does help firms invest and stick around for longer but risks supporting “poor dogs” that capital markets would likely not fund. That is, the finding that primarily “unhealthy” but not “healthy” loss firms’ investment responds to direct cash injections implies that, in normal times, capital markets do a fairly good job in helping “healthy” loss firms weather their temporary crisis. So why and how would the government then need to help “healthy” firms with Corona?

While capital providers (e.g., the Hausbank in Germany) are well informed about whether a business was “healthy” prior to Corona, they currently face high uncertainty as to whether and when they will be “healthy” again. Hence, by bearing some of the uncertainty lenders would otherwise face, the German emergency measures for example support their lending decision but don’t take it. This mechanism exploits the information lenders and firms have about the current situation and helps with the uncertainty that lenders would otherwise face (and likely not be willing to bear).

Learn more in "Tax Loss Carrybacks: Investment Stimulus versus Misallocation" by Maximilian Müller, Inga Bethmann, and Martin Jacob (2018), The Accounting Review (2018, Volume 93, Issue 4, pp. 101-125) at American Accounting Association.

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