Public Stakes in Small Firms

(Bloomberg) — European policy makers who frantically assembled plans to help their economies weather the coronavirus lockdowns are starting to focus on how to prevent cascading bankruptcies that could derail the rebound.

The next big idea gaining traction among officials and economists is potentially taking stakes in small and medium-sized businesses, in contrast to early efforts that relied heavily on loans to keep corporations afloat.

The European Commission and the Bank of England have both floated the concept, and France’s finance ministry is examining the option. So is Germany’s economy ministry, according to a spokesman. The nation’s DIHK business association, which says almost half of its members have seen their capital depleted, is supportive.

Equity support in itself isn’t new — banks were bailed out during the global financial crisis and Germany still holds a more than 15% stake in Commerzbank.

But efforts that focused on large companies triggered a backlash against authorities for ignoring struggling smaller businesses that employ the vast majority of workers.

Now, the disruptions from the pandemic mean many of those businesses face a cashflow squeeze that could see them fail even as they resume operations.

Such intervention would thrust the state into an even-deeper role in managing the economy, and would inevitably lead to accusations of picking winners and losers. The economists backing such proposals, however, say relying on yet more loans could weigh so heavily on businesses that it sucks the life out of the economy.

“There’s a risk that companies will have to ramp up debt to such an extent during the crisis that aggressive investments afterward become unlikely,” said Jan Krahnen, director of the Leibniz Institute for Financial Research SAFE in Frankfurt, and one of the authors of a proposed European Union-wide equity proposal. “This would be counteracted directly with another form of financing.”

Solvency Support

The EU Commission identified corporate solvency as a key risk this week, warning that a rise in bankruptcies “could amplify and lengthen the pandemic shock while raising non-performing loans.”

It estimates as much as 720 billion euros ($811 billion) will be needed this year alone to ensure the survival of otherwise-viable firms in the EU. Officials have proposed a “solvency support instrument” — as part of the bloc’s recovery fund that leaders will debate this month — which would leverage a small public budget to mobilize 300 billion euros in private equity investment.

“We’re entering a phase where corporate solvency may be shaken as national governments could start reducing the policy support put in place in the first phase of the crisis,” OECD Chief Economist Laurence Boone told a European Parliament hearing in June. “Where state aid has taken the form of equity injections, corporates will be more resilient.”

The proposal by Krahnen and five economists from other universities argues for a “European Pandemic Equity Fund” that would make an initial cash investment in return for a share in future earnings. It would be open to companies of all sizes, and firms could ultimately buy themselves out of the scheme at a pre-set price.

Similar to the EU proposal, it would leverage a smaller public budget by selling bonds or take investments from institutional investors such as pension funds and insurers.

Bank of France Governor Francois Villeroy de Galhau said Thursday that “quasi-capital measures” for small businesses of as much as 20 billion euros will be needed. While there have been lots of ideas, “no instrument is really ideal, and it will probably be best to experiment with several in parallel,” he said in an annual letter to the country’s president.

In the U.K., the BOE sees the cash-flow deficit at companies reaching 50 billion pounds ($63 billion), and Governor Andrew Bailey has pledged to work with the government on ways to boost equity finance to plug that gap.

Such plans would throw up some dilemmas. European Central Bank President Christine Lagarde says the crisis will probably accelerate preexisting trends toward less globalization, more digitization and greener industries. Governments may feel not all parts of the economy should be restored to their pre-virus standing.

Researchers at the Bruegel think tank in Brussels wrote in an opinion piece that any publicly-backed equity fund should set a “clear political direction” with post-virus goals such as climate neutrality and social cohesion.

“I imagine this is very hard to do in practice,” Patrik-Ludwig Hantzsch, head of economic research at debt collector Creditreform, said. “How do you want to select companies that only got in trouble because of the crisis, and ideally be all about green technologies? The devil is in the details.”

Others say publicly-backed loans that were handed out in recent months could be the starting point for equity support. Olivier Blanchard, Thomas Philippon and Jean Pisani-Ferry wrote a paper for the Peterson Institute said that firms could get the option to convert debt into “equity or quasi-equity in the form of preferred shares or, for privately held firms, higher profit taxes.”

If that were to happen in Germany, for example, where companies have applied for more than 50 billion euros worth of loans from the state-back development bank KfW, thousands of firms could find that the state has joined their shareholder roster.

“These loans have not been used before during times of economic crisis — nobody knows what will happen now,” said Dirk Ehnts, a Berlin-based economist who co-founded Pufendorf Gesellschaft, an NGO focusing on political economy education. “The German government, without initially intending it, could become a very, very big business owner.R

(Adds comment from Villeroy in 14th paragraph.)

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