A guest post by Niall McGeever (Central Bank of Ireland) on new company registrations and corporate insolvency in Ireland during the pandemic. [Disclaimer: This blog represents the author’s views and not those of the Central Bank of Ireland]
The severity of the COVID-19 shock and the modest liquid asset holdings of many Irish firms (Financial Stability Review 2020 I; McGeever et al., 2020) raises the question of how the pandemic is affecting business dynamism and failure rates. A marked reduction in new firm formation or a spike in insolvencies could lower the productive capacity of the economy and negatively affect output and employment.
Cecilia Sarchi, Maria Woods, and I look at recent trends in a new Economic Letter on Irish company births and insolvent liquidations during the COVID-19 shock.
There’s lots of economic research showing the importance of new firms for productivity and employment growth. Lawless (2013), for example, shows that young firms contribute disproportionately to employment growth in Ireland.
While a certain level of insolvency over time is inevitable and even desirable to ensure resource re-allocation to productive firms, the failure of otherwise viable firms due to the pandemic could reduce output and productivity growth. See Lambert et al. (2020) for more discussion on this point.
The chart below, Figure 2 from the Letter, shows the new company registration rate between January 2001 and September 2020. The rate averages around 9.5 per cent per annum and is broadly pro-cyclical.
The initial Covid-19 shock coincided with a sharp decline in new company registrations, with the rate falling to 5.3 per cent in April and 6.1 per cent in May. The Companies Registration Office tell us that over 90 per cent of applications to register a new company are made online, so the decline in April and May cannot be explained by procedural delay due to the pandemic. Instead, it likely reflects a temporary decline in both new enterprise formation and stalled investment decision-making by pre-existing corporate groups.
The largest declines during this period were, perhaps unsurprisingly, in Accommodation and Food and in Arts, Entertainment and Recreation. New registrations in these sectors were down 50 per cent on the same period in 2019.
Whilst the number of registrations in the first nine months of 2020 were down around 12 per cent on the same period of 2019, new company registrations rebounded quite strongly over the summer and had returned to roughly pre-pandemic levels by September. An emerging trend in the Wholesale and Retail trade category is the consistent increase in new registrations in “retail sales via mail order houses or via internet” and in “other retail sales not in stores, stalls or markets” between June and September relative to the same period in 2019. This trend is also reflected internationally. US Census Bureau data, for example, shows higher new business applications by non-store (e.g., internet sales) retailers during 2020.
We next look at insolvent liquidations. The next chart (Figure 4 in the Letter) shows the insolvent liquidation rate from January 2001 to September 2020. The rate generally tracks macroeconomic conditions very closely and it is worth noting that it rose notably rose with the unemployment rate in early 2008.
The immediate impact of Covid-19 shock was to sharply reduce insolvent liquidations. The annualised rate was exceptionally low at 0.07 per cent in April 2020 and only a touch higher at 0.10 per cent in May. This is due principally to the inability of company directors to safely convene creditors’ meetings. Prior to the pandemic, it was a requirement to hold a physical meeting with creditors to initiate a creditors’ voluntary liquidation. This became impractical during the acute phase of public health restrictions and so the main channel for insolvent liquidations was blocked. This procedural issue was quickly resolved and the Oireachtas passed a company law amendment to facilitate creditors’ meetings by electronic means.
The insolvent liquidation rate reverted to pre-pandemic levels in June and showed no signs of a marked increase up to September. At a sectoral level, Accommodation and Food and Wholesale and Retail Trade show signs of higher liquidations both during the pandemic and relative to 2019. These patterns are aligned with the negative labour market shocks in both sectors.. To a lesser extent, we also see the Arts and health sectors recording higher numbers.
Despite the clear evidence of financial distress facing many firms, there is no evidence yet of a marked increase in corporate insolvencies. The striking contrast between the insolvent liquidation rate and current labour market conditions is unusual and points to the significant role of government supports, loan payment breaks, and forbearance from other creditors in helping firms to stay cash-flow solvent.