New York – Despite trillions of dollars of stimulus sloshing around and credit being funneled into the global economy, the COVID-19 pandemic is forcing countless businesses into bankruptcy. The weak are getting weaker, and the big are thrown lifelines. That divide will only grow wider.
The case of Japan, where insolvencies are rising sharply, shows that no matter how much cash you have, size matters more: Micro-enterprises across all sectors account for around 70 percent of companies going under, despite a large portion having net cash. Almost 60 percent of small companies in the benchmark Topix stock index are net cash, compared to around 40 percent of the larger ones. Overall, that’s much higher than global peers: The figures are 15.6 percent of S&P 500 non-financial companies, and around 23 percent of the MSCI Euro.
Bankruptcies at large Japanese companies have fallen. So it’s curious that risk-averse, mom-and-pop outfits sitting on cash are falling victim faster everywhere, not just where they make up a majority of firms, such as restaurants and small retailers.
Years of low investment and failure to grow equity capital have made them more vulnerable. An analysis by Goldman Sachs Group Inc. shows that while larger companies have been able to build their equity buffers, the tiniest haven’t.
Businesses with capital of more than ¥1 billion have corporate equity ratios of around 30 percent and have broadly trended upward; they can stand to absorb losses. The ratios of those with less than ¥10 million are close to 15 percent and have stayed flat over the last couple of decades. The moment earnings get hit, they face a wipe out. Low tolerance for losses means micro-enterprises throw in the towel at any semblance of a prolonged downturn. At slightly larger firms, the acceptance of taking a hit even if working capital is insufficient “has increased substantially,” they say, helping avert bankruptcy.
What of the cash cushions? Those are a strategic asset right now and will hold Japanese companies in good stead. After struggling through previous financial crises, they turned to hoarding cash and started switching their preferred funding away from debt. As a percentage of gross domestic product, firms’ liquid assets have risen from 103 percent in 2003 to 136 percent last year, according to Capital Economics. Micro-enterprises have been the bigger savers and kept more in cash. That gave them more discretion on where and when to invest. If things were uncertain, as now, they could hold back; if money was flowing in, then put it toward spending on fixed assets. The impetus to grow was largely lost.
As Goldman Sachs’ Tomohiro Ota says, the root of the problem for micro-enterprises is low productivity and profitability. A survey in April showed that Japanese companies were decreasing investment because “the future cannot be foreseen.”
Sure, the size of companies going under is small, and so will be the total liabilities that creditors are left holding. The impact on the macro economy may not feel that severe to start. But if the numbers rise sharply, things could turn sour soon — and deepen the challenges for micro firms, where some 24 percent of employees in Japan work.
This situation points to a more persistent problem: access to credit for micro-enterprises. Japanese banks, even with their low loan to deposit ratios, tend to rely on hard, fixed assets for collateral. That’s a setback for little companies, and means growing their asset bases or businesses isn’t as easy. Small remains small.
Since February, the government has doled out trillions of yen in aid, including tax breaks and refunds, employment subsidies, cash grants and interest-free, unsecured loans. Yet despite such largess, when things go bad, they do so quickly. Bankruptcies are expected to rise. Larger companies tend to have far better access to commercial paper and bond markets, and find ways to leverage stimulus loan programs. Smaller ones get caught up in bureaucratic and costly paperwork trying to claim benefits.
A crisis brings the future into focus. Many of these businesses are family-owned, and succession planning — whether that’s selling, handing it over or closing — is harder in the midst of COVID-19. Much like in the United States, where the Chapter 11 process of reorganizing firms and their balance sheets suits larger companies, shutting down is just the cheaper and less cumbersome option. The incentive increases as Japan’s population ages and businesses don’t have a successor. In the past decade, around 95 percent of bankruptcies have been liquidations.
Japan’s small-firm problem has become structural. Even if government support helps contain bankruptcies, it may ultimately lead to the preservation of low-margin companies without boosting their profitability or productivity, as Goldman’s Ota says. The “measures to bolster capital could prove a double-edged sword over the long term,” the report notes.
Coming out of COVID-19, the inequalities between large and small firms will only be more pronounced.
Anjani Trivedi is a Bloomberg Opinion columnist covering industrial companies in Asia.