Assessment of Corporate Sector Value and Vulnerability: Links to Exchange Rate and Financial Crises (World Bank Technical Papers)

Annotation World Bank Technical Paper No. 455. "Once equity has fallen below a certain threshold for a significant period of time, it triggers a suspension of debt payments and distorts incentives for equity holds and managers. But what is a significant period of time? You or I could pay a $10 million annual mortgage payment for a day or two but not two or three months. Similarly, owners and managers can withstand short periods of illiquidity or negative equity but not longer ones. At some point in time, the inability to meet obligations and perception of continued difficulties creates a system-wide breakdown in debt payments." The relationship between the corporate sector and a country's macroeconomy is receiving increased attention from policymakers and investors, especially those affected by the Asian crisis. Recent crises have pointed out the importance of improving our understanding of the links between the corporate sector, the financial sector, and the macroeconomy in a world of volatile capital flows. Assessing the vulnerability of the corporate sector and its links to financial and exchange rate crisis is important for both improved surveillance and in the design of policies in crisis countries. However, the analytical and operational tools available to policymakers and investors to analyze this problem have been limited. This Technical Paper was prepared as part of an initiative to develop new frameworks which can integrate state-of-the art corporate finance principles, macroeconomic, and financial sector analysis. An innovative yet practical framework is provided which has numerous applications for assessing corporate sector vulnerability, design of corporate restructuring strategies, as well as financial sector and macroeconomic policies. It will be of interest to bankers, economic policymakers, corporate finance specialists, and macroeconomists. This paper presents an innovative yet practical framework to assess corporate sector vulnerability and the links to exchange rates and financial crises that bridges the gap between corporate finance and macroeconomic analysis. This framework provides a "missing link" describing how changes in aggregate value of the corporate sector are interrelated with exchange rate crises, financial crises, and associated fiscal costs of bank recapitalization. The factors that can make the corporate sector particularly vulnerable include both sector-specific characteristics (leverage, composition of debt, maturity of debt, hard currency profits, etc.) and characteristics of the current account adjustment process that feed back on corporate balance sheets. The framework has multiple applications. It can help policy makers and investors understand past crises and assess risks of future crises. It can also help improve surveillance as well as improve policy design at the macroeconomic, financial, and corporate sector levels The economic value estimate (EVE) is the aggregate estimated economic value of the corporate sector.