Why government bail-outs in times of financial crisis can be good for business

Times of financial crisis lead banks to tighten their lending. This in turn can adversely affect the economy, creating negative spillover effects for the corporate sectors, such as lower stock market valuations for borrowing firms.

To help restore liquidity and stability to markets during the global financial crisis of 2007-2009, the US government was forced to implement the Capital Purchase Program (CPP), which enabled it to bail out the troubled banking industry using tax payers’ money.

In a paper titled The impact of government intervention in banks on corporate borrowers’ stock returns, ERIM researchers <link people lars-norden>Lars Norden, Peter Roosenbom, and Teng Wang investigate for the first time the effects such interventions have on stock market performance, and explore the importance of bank-firm relationships in light of the CPP. 

The researchers find that bank-firm relationships serve as a transmission channel for positive spillover effects on the corporate sector in situations when shocks to banks are mitigated through government interventions. Crucially, they find that CPP interventions in banks do indeed have a significantly positive impact on the borrowing firms’ stock returns.

Firm characteristics affect the positive impact of CPP intervention, however, with smaller, riskier, and bank-dependent firms benefiting more from these government capital infusions.

• Download The impact of government intervention in banks on corporate borrowers’ stock returns from Cambridge Journals