Sovereign risk and intangible investment

Abstract

This paper measures the output and TFP losses from sovereign risk, considering firm-level intangible investment. Using Italian firm-level data, we show that firms reallocated from intangible assets to tangible assets during the 2011–2012 Italian sovereign debt crisis. This asset reallocation is more pronounced among small firms and high-leverage firms. This reallocation affects aggregate output and TFP. To explain the reallocation pattern and quantify the output and TFP losses, we build a sovereign default model incorporating firm intangible investment. In our model, sovereign risk deteriorates bank balance sheets, disrupting banks’ ability to finance firms. Firms with greater external financing needs are more exposed to sovereign risk. Facing tightening financial constraints, firms shift their resources towards tangibles because they can be used as collateral. We find that elevated sovereign risk explains 45% of the observed output losses and 31% of the TFP losses in Italy from 2011 to 2016.