17 Aug 2020

Equity capital of Italian companies melts away due to the corona crisis

Covid-19 shock mainly affects small and medium-sized enterprises

Small and medium-sized enterprises (SMEs) in particular must fear for their equity capital as a result of the economic restrictions in the corona crisis. Calculations by an international research team for a current SAFE Working Paper show, using Italy as an example, that the lockdown for companies would lead to a total annual decline in profits of up to 18 percent of Italian GDP. If the forecasts actually come true, there is also a threat of a massive increase in unemployment.

"Our results show that the corona crisis probably hits smaller companies hardest, which generally have lower profitability, lower capitalization, and less access to the capital markets," says Loriana Pelizzon, head of the Financial Markets department at the Leibniz Institute for Financial Research SAFE. For the SAFE Working Paper, Pelizzon and her research colleagues analyzed a representative sample of almost 81,000 mostly private sector companies in Italy – the country in Europe that was first and most severely affected by the effects of the Covid-19 pandemic.

The researchers forecast that, as a result of the corona shock, the companies in the sample will have to cope with a total annual drop in profits of 170 billion euros after three months of lockdown without sustained recapitalization or debt restructuring measures which corresponds to about ten percent of Italian GDP. The total equity shortfall of the companies for this period of time amounts to 117 billion euros. A good 13,500 companies with around 800,000 employees would thus find themselves in financial distress.

Above all manufacturing industry and wholesale trading struggle with profit losses

"If all these companies were to go bankrupt, the consequences for the labor market would be more serious than in the years between 2007 and 2013 as a result of the financial and public debt crisis," Pelizzon said. In a scenario lasting more than half a year, the profit losses of the analyzed companies would amount to 321 billion euros or 18 percent of the Italian GDP, and there would be a shortage of equity capital of 259 billion euros.

The consequences would have to be borne above all by SMEs and less by listed companies. The predicted decline in profits is concentrated in manufacturing and wholesale trading in the industrial north of Italy. Within manufacturing, the most affected sub-sectors are fabricated metal products, industrial and commercial machinery, computer equipment and transport equipment. "Surprisingly, the profits and equity levels of companies in the recreation services and tourism sectors are comparatively only slightly affected in our analysis," says Loriana Pelizzon. According to the SAFE Working Paper, the reason for this is that these sectors are very labor intensive and most of the labor costs during the lockdown were covered by public subsidies.

Across Europe, policy measures aimed at the equity structure of acutely crisis-ridden companies have so far been rare. "The supply of liquidity through debt financing alone will not be sufficient to counter the crisis in a sustainable manner. Counter-financing already highly indebted companies with even more debt will only keep these companies alive temporarily without restoring their solvency," explains Pelizzon.

Download the SAFE Working Paper