Insolvency and Debt Overhang Following the COVID-19 Outbreak: Assessment of Risks and Policy Responses

By Lilas Demmou, Sara Calligaris, Guido Franco, Dennis Dlugosch, Müge Adalet McGowan and Sahra Sakha, OECD Economics Department

A swift response of policy makers across OECD countries has helped businesses to bridge the short-term liquidity shortfalls due to the economic shock following the COVID-19 outbreak (Demmou et al., 2021a). However, many countries have entered a second phase of the crisis and the shock is translating into an enduring risk of a wave of corporate insolvencies as well as in a significant increase in leverage, depressing investment and job creation for long. A recent OECD working paper (Demmou et al., 2021b) investigates the extent of these risks and outlines policy options to address them.

A large portion of firms are predicted to become distressed and will find it hard to service debt, with negative consequences on future investment

Using a simple accounting exercise, we evaluate quantitatively the impact of the COVID-19 pandemic on firms’ long-term viability under an “upside” and a “downside” scenario. According to our estimates, around 7% (9%) of otherwise viable companies are likely to become distressed (i.e. their net equity is predicted to be negative) in the upside (downside) scenario (Figure 1), and between 30% and 36% of firms would no more be profitable enough to cover their interest expenses. However, these percentages are heterogeneous across sectors and type of firms. Firms in  industries that use intangible assets (such as intellectual property, data or software) intensively are significantly impacted but better positioned to bridge the crisis, while the Hospitality, Entertainment and Transport sectors are the most severely hit. Young, small and low productivity firms are predicted to suffer more compared to their old, large and high productivity counterparts.

The reduction in equity relative to a business-as-usual scenario has immediate consequences on firms’ leverage ratios: the ratio of total liabilities to total assets would increase by 6.7 p.p. in the upside scenario and 8 p.p. in the downside scenario for the median firm in the sample (Figure 2, Panel A). In turn, the increase in the level of indebtedness can push firms towards the so-called “debt overhang” risk. Based on an empirical investigation of the historical relationship between indebtedness and investment, our findings suggest that an increase in the debt to total assets ratio comparable to the one predicted by our accounting model could imply a decline of the ratio of investments to fixed assets by 2 p.p. (2.3 p.p.) in the upside (downside) scenario (Figure 2, Panel B).

Policies to support the corporate sector’s ability to weather the crisis and recover fast

Distress and debt overhang of non-financial corporations could threaten the recovery by compromising firms’ ability to invest, suggesting that governments should carefully design support packages in order to limit the increase in corporate indebtedness. Moreover, given the difficulty to screen ex-ante firm performances, policy makers face the additional challenge of finding the right balance between the risk of supporting potentially non-viable firms against the risk of forcing viable and productive firms into premature liquidation. In the current circumstances, the balance of risks should be tilted in favour of the former, as the risk to push-out of the market many viable firms is particularly high. To this end, governments may adopt the following cascading approach, regularly re-assessing and adapting support as the economic situation evolves:

  • Support measures should first aim at “flattening the curve of insolvencies” by ensuring that distressed firms have access to additional resources but avoiding the increase in debt that follows debt-based support. To mitigate debt overhang concerns, measures should increasingly include complementary non-debt financing instruments to recapitalise firms: a) equity and quasi-equity injections (e.g., preferred stocks, convertible loans); b) phasing in an allowance for corporate equity; c) debt-equity swaps to provide firms with the required liquidity, without increasing their leverage; d) state-contingent loan repayment (e.g. linked to business returns) in the form of future taxes; e) convert loans into grants.
  • If this strategy proves insufficient, policy makers could encourage timely debt restructuring to allow distressed firms to continue operating smoothly. This would help to coordinate creditors’ claims in a manner that is consistent with preserving the viability of the firm and its capacity to invest going forward. Relevant measures include establishing legal conditions favouring new financing for distressed firms, reforms to insolvency regimes including promoting pre-insolvency frameworks and specific procedures to facilitate the restructuring of SMEs.
  • These two steps aim to reduce the number of viable firms that would otherwise be liquidated. To deal with firms that would still be non-viable despite public support and debt restructuring, governments could improve the efficiency of liquidation procedures to unlock potentially productive resources. Providing the institutional conditions for a fresh start by removing barriers that might push debtors to delay liquidation, in particular by reforming the personal insolvency regime, remains a key challenge in several countries.

Further reading

Demmou L., G. Franco, S. Calligaris and D. Dlugosch, (2021a), “Liquidity shortfalls during the COVID-19 outbreak: assessment of risks and policy responses”, OECD Economics Department Working Papers, No 1647, OECD Publishing.

Demmou L., S. Calligaris, G. Franco, D. Dlugosch, M. Adalet McGowan and S. Sakha, (2021b), “Insolvency and debt overhang following the COVID-19 outbreak: assessment of risks and policy responses”, OECD Economics Department Working Papers, No 1651, OECD Publishing.

Should we worry about high household and corporate debt?

By Catherine L. Mann,  OECD Chief Economist and Head of the Economics Department, and Filippo Gori, Economist, Macroeconomic Policy Division, OECD Economics Department

Household and corporate debt in many advanced and emerging market economies is high in the wake of the financial crisis and following a decade of low global interest rates.  Should we be worried by these developments?

The forthcoming OECD Economic Outlook special chapter on “Resilience in a Time of High Debt” looks at how high debt-to-GDP ratios can increase vulnerability in the short run. While higher indebtedness does not necessarily imply that problems are just around the corner, it does increase vulnerability to shocks and the on-going deterioration of credit quality, changes in the structure of corporate financing, increased forex risk and buoyant asset price dynamics raise concerns.

The impact of high debt on the sustainability of growth in the medium term is often overlooked. While finance is needed to support economic activity and innovation, it can increase risks, lower growth, and raise inequality in the longer term.

The assessment highlights some key features of the post-crisis expansion of private sector debt for risk:

  • There has been a significant shift in corporate finance towards bonds and a substantial decrease in credit quality, including a surge in issuance of non-investment grade bonds, weaker covenants and low bond ratings (Çelik et al., 2015). While deepening of bond markets can be positive, this points to higher credit risk and rollover risk.
  • There has been a substantial expansion of international bond markets and foreign-currency borrowing. This helps to share risk and improves access for countries with limited domestic financial markets. However, it increases the risk of international spillovers. The rise in foreign-currency denominated bond issuance – much of which via foreign subsidiaries – exposes borrowers more to exchange rate risk.
  • On the asset side, more credit risk now lies with bond holders. They also face interest rate risks and the low level of coupon rates and rising maturity means that there are now record levels of duration risk, implying that bond values are very sensitive interest rate changes.
  • Household debt ratios are closely linked to house prices and the credit cycle in mortgages: some OECD countries that have experienced the strongest increases in household debt since the crisis have also the steepest rise in house prices. The housing cycle is an important risk factor as excessive house price developments are predictive signals of future recessions (Caldera Sánchez, et al., 2017). A number of advanced economies have experienced worrying increases in house prices in recent years, while household debt as a share of income in some Asian countries is reaching levels typically seen in advanced economies.


The efficiency of capital allocation is critical to ensure that corporate debt is sustainable and does weigh on medium-term growth. However, weak investment since the crisis raises concerns that debt is not being used to finance long-term productive capacity. Over-indebted firms tend to lose business dynamism, failing to keep up with the required investment to remain competitive, and become “zombie” firms, not only impairing their own prospects but also reducing performance by competing firms (Adalet McGowan et al., 2017).

An integrated policy approach is needed to enhance the financial resilience of economies to shocks and minimise the risks of sub-par growth in the medium term, balancing risks and the growth impacts. This needs to draw on a familiar menu of policy tools including an appropriate balance of macroeconomic policies and use of macroprudential instruments.

However, the approach needs to go beyond cyclical fixes and address underlying structural features of the economy and policy that can lead to too much corporate and household debt. For corporate finance, a sounder and healthier financial system would reduce the tax bias towards debt, deepen equity markets and improve the design of insolvency regimes. For housing markets, removing tax and other subsidies for housing and making housing supply more fluid would enhance the resilience of household debt.

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Adalet McGowan, M., D. Andrews and V. Millot (2017a), “Insolvency regimes, zombie firms and capital reallocation”, OECD Economics Department Working Papers, No. 1399, OECD Publishing, Paris. DOI:

Çelik, S., G. Demirtaş and M. Isaksson (2015), “Corporate Bonds, Bondholders and Corporate Governance”, OECD Corporate Governance Working Papers, No. 16, OECD Publishing, Paris.

Caldera Sánchez, A., et al.  (2016), “Strengthening economic resilience: Insights from the post-1970 record of severe recessions and financial crises”, OECD Economic Policy Papers, No. 20, OECD Publishing, Paris.

OECD (2017), OECD Economic Outlook, Volume 2017 Issue 2, OECD Publishing, Paris.