The Real costs of Industry Contagion

In this paper I analyze whether the higher financing costs following the distress or bankruptcy of one firm affect the real investment decisions of non-distressed industry competitors. To achieve identification of the causal effect of contagion on investment, I use a difference-in-differences approach that compares within-firm changes in investment around the industry distress for non-distressed competitors with large proportions of their debt maturing immediately after the industry distress, relative to other non-distressed competitors in the same industry but that did not have debt maturing immediately after the industry distress. Results suggest that the former firms, which are more affected by the higher costs of financing due to contagion, reduce their capital expenditures to capital ratio by around 10% more than the less-sensitive firms. Further results show that contagion effects are milder in concentrated and low-leveraged industries, as well as in industries that do not rely too heavily on external financing.