23 Apr 2020

A pandemic fund: How to support companies in the crisis without overwhelming them with debt

Cash-against-tax-surcharge scheme – financial experts specify the conditions and principles for a pan-European fund

Financial economists around the Leibniz Institute for Financial Research SAFE propose an equity-like financing scheme instead of support through credits. The scheme would support small and medium enterprises (SME) affected by the corona pandemic without increasing their debt burden dramatically. In the new SAFE Policy Letter No. 84, the team of experts shows how this kind of European Pandemic Equity Fund (EPEF) can be set up such that both risks and rewards are effectively shared among the European Union member states. The authors include Arnoud Boot (University of Amsterdam), Elena Carletti (Bocconi University), Hans-Helmut Kotz (Harvard Center for European Studies and SAFE), Jan Pieter Krahnen (SAFE), Loriana Pelizzon (SAFE and Goethe University Frankfurt), and Marti Subrahmanyam (New York University Stern Business School and SAFE).

The key idea of the fund is to support companies with cash in form of equity, rather than using conventional debt, or debt guarantees. In return, the supported companies have to pay higher taxes on profits as soon as they are better off. However, a "buy-out option" at a pre-set price allows companies to terminate the additional tax prematurely. The capital is channeled to firms with healthy business prospects, relying on local banks expertise and national authorities. The necessary capital for this fund must be raised jointly by the EU member states – and possibly also by private investors. This would share the risks of participation, but also the potential returns after economic recovery, especially in the SME sector, across the EU.

The paper discusses the details of the design of the fund, including the operational details of the investment flow and suitable financing and sourcing options. It also addresses the problems of moral hazard and adverse selection (moral hazard and adverse selection).

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