Firm-Level Debt and Employment by Alireza Sepahsalari, University of Bristol

Micro evidences on Swedish firms suggest a strong association between firms’ short-term borrowing and change in employment as well as firms’ long-term borrowing and capital adjustment. This paper formalises these links by developing a DSGE model where firms manage a debt portfolio while facing a frictional financial market. In this framework, long borrowing is restricted by a collateral constraint and short borrowing is subject to the default risk. Growing firms are restricted by a collateral constraint therefore, they use more short borrowing to hire more labour. In contrast, shrinking firms hoard capital and hence access to more long debt when downsizing. The model predicts that a financial tightening strengthens the association between labour adjustments and short debt and the association between capital adjustment and long debt.  These results are similar to empirical patterns observed during the Great Recession.