Case Study
PROGRAMME Master of Business Administration
MODULE Managerial Economics
YEAR One (1)
INTAKE July 2021
TOTAL MARKS 100
FORMATIVE ASSESSMENT 1 [100 Marks]
Case study
Financing Firms in Hibernation during the COVID-19 Pandemic
By Tatiana Didier, Federico Huneeus, Mauricio Larrain, and Sergio L. Schmukler (2021)
Abstract
The coronavirus (COVID-19) pandemic halted economic activity worldwide, hurting firms and pushing many of them toward
bankruptcy. This paper discusses four central issues that have emerged in the academic and policy debates related to firm
financing during the downturn. First, the economic crisis triggered by the pandemic is radically different from past crises,
with important consequences for optimal policy responses. Second, it is important to preserve firms’ relationships with key
stakeholders (e.g., workers, suppliers, customers, and creditors) to avoid inefficient bankruptcies and long-term detrimental
economic effects. Third, firms can benefit from “hibernation,” incurring the minimum bare expenses necessary to withstand
the pandemic while using credit to remain alive until the crisis subdues. Fourth, the existing legal and regulatory
infrastructure is ill-equipped to deal with an exogenous systemic shock like a pandemic. Financial sector policies can help
channel credit to firms, but they are hard to implement and entail different trade-offs.
Conclusion
Because governments have limited resources, they need to prioritize which policies to pursue when trying to save firms
from collapsing during the COVID-19 pandemic, at the same time that they evaluate their trade-offs. This is not easy to
achieve given the urgency of the needs and the speed at which decisions must be made. Nevertheless, it is worth keeping
several considerations in mind when designing different policy responses. For example, policy makers need to make
decisions on how much to allocate to large firms versus SMEs, to firms that have relationships that are more 16 difficult to
reconstruct, or to firms that would be more disruptive for value chains if they were to go bankrupt. They might even be
pushed to decide whether some essential industries (such as basic infrastructure, health, and education) or industries hit
hardest by the shock (such as travel, tourism, and other services) are worth assisting over others. Furthermore, policy
makers need to determine how much they condition the assistance on keeping certain relationships over others. For
example, governments are usually keen on forcing firms to keep workers on their payroll, while avoiding payments to
shareholders. However, determining which relationships are more valuable than others for different firms is not trivial.
Governments also need to think about how to allocate resources over time. Firms might be in hibernation and need funds
for several months, using bridge financing to make it through the lockdown period. During this critical time, government
assistance might be needed the most, as banks and investors face higher uncertainty about the length of the pandemic and
the related probability of firm survival. Eventually, surviving firms will need additional lines of credit to restart or jump-start
their operations when they stop hibernating. Private lenders might be more willing to lend at that stage when uncertainty has
diminished and they would be in a better position to assess firms’ prospects and credit risks.
The scope for policy action implies stark differences between developed and developing countries, as well as among
countries within each group. Their different initial conditions determine the set of policies they are able to implement and at
which cost (Hausmann, 2020; Loayza and Pennings, 2020). Countries with underdeveloped financial markets, less fiscal
slack, and more constrained central banks will face greater challenges to channel credit to firms so as to avoid a breakup in
their relationships. Nonetheless, many developing countries have banking systems that they could use to channel credit to
firms and tools to assist banks if they face funding difficulties at a later stage. Moreover, the fact that developing countries
generally have more informal firms might help them reestablish relationships faster once the lockdown measures are
eased. These informal firms might be better targeted through programs that assist households, which can use some forms
of personal loans. Moreover, pressure from households and firms with fewer resources in developing countries could make
the lockdown period shorter, triggering a higher rate of infection and more rapid herd immunity, at a tragically higher
mortality rate, but requiring fewer resources for the quicker hibernation phase. With the rise in global risk, developing
countries have also faced a sudden stop in capital inflows, higher costs to issue new debt in capital markets, and sharp
depreciations of their domestic currencies. These significant macroeconomic challenges, combined with the large financing
needs that arise from the pandemic shock, could trigger widespread sovereign debt restructurings (Blanchard, 2020;
Gourinchas and Hsieh, 2020). In turn, they could be followed by widespread turbulence in the corporate sector, especially in
countries where firms entered the shock with high outstanding debt levels. The liquidity issues in developing countries
might thus rapidly turn into solvency problems–both at the firm and country levels. Multilateral pol17 icy action, involving
international financial institutions and creditor countries, might help resolve a problem that can become common across
developing countries.
Lastly, in designing policies for both developed and developing countries, it is useful to acknowledge the transfers that
policy actions produce across different agents of the economy. The lockdown policies will tend to protect the more
vulnerable older generation, while restricting the economic activities of the younger generation, which has a lower risk of
becoming seriously ill. This effectively induces transfers from the young to the old, given that some of the costs of such
policies will not necessarily be recovered (Reis, 2020). Policies to keep firms alive, however, do not produce the same type
of intergenerational transfers. Whereas they will be paid mostly by the young, that same generation will also benefit the
most from keeping firms alive during the pandemic. Within the young generation, the socialization of losses still entails
transfers. Those that have the resources to survive the lockdown without public assistance will in effect subsidize those that
receive such help.
https://openknowledge.worldbank.org/bitstream/handle/10986/33611/Financing-Firms-in-Hibernation-During-the-COVID-19-
Pandemic.pdf?sequence=1
or
https://0-www-sciencedirect-com.innopac.wits.ac.za/science/article/pii/S1572308920301406
DIDIER, T., HUNEEUS, F., LARRAIN, M. & SCHMUKLER, S. L. 2021. Financing firms in hibernation during the COVID-19
pandemic. Journal of Financial Stability, 53, 100837
Answer ALL the questions in this section.
Question 1 (15 Marks)
Given the transitory nature of the shock, a good option might be hibernation: slowing the economy until the pandemic is
brought under control, while using fiscal policy to compensate for some of the many losses that the economy needs to
withstand. Critically discuss the activities that characterised firm hibernation as a result of the fall-out due to the Covid-19
pandemic.
Question 2 (15 Marks)
Unlike the previous crises, the Covid-19 pandemic originated outside the financial sector impacting on the corporate sector
in a number of ways. Citing examples from this case study, critically discuss how the pandemic affected the resilience of the
corporate sector.
Question 3 (60 Marks)
The COVID-19 crisis and the “hibernation period” have triggered extensive and immediate policy responses from fiscal and
monetary authorities around the world.
3.1 Using examples from the case study and in your country, discuss some of the fiscal policy (15 marks)
responses and interventions that support the small and medium enterprises (SME) within the
corporate sector.
3.2 Large firms have larger spillover effects and generate greater externalities in the economy than (15 marks)
individual SMEs. With the aid of examples and graphs (where appropriate) critically discuss
this assertion.
3.3 Critically assess some of the unintended consequences of these measures on government (15 marks)
finances.
3.4 Central banks across the world swiftly responded to the Covid-19 pandemic with accommodative (15 marks)
interventions. Discuss some of these responses and how they have benefited corporates to absorb
the impact of the pandemic.
Question 4 (10 Marks)
With the rise in the global risk from the Covid-19 fall out, developing countries were faced with “sudden stops” or reversal in
capital inflows. Critically evaluate the potential macroeconomic consequences associated with “sudden stops” or reversal in
capital inflows.
