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| In the wake of the recent financial crisis many governments extended public guarantees to banks. We take advantage of a natural experiment in which long-standing public guarantees were removed for a set of German banks following a lawsuit to identify the real effects of these guarantees on the allocation of credit (“allocative efficiency”). Using matched bank/firm data we find that public guarantees reduce allocative efficiency. With guarantees in place poorly performing firms invest more and maintain higher rates of sales growth. Moreover firms produce less efficiently in the presence of public guarantees. Consistently we show that guarantees reduce the likelihood that firms exit the market. These findings suggest that public guarantees hinder restructuring activities and prevent resources to flow to the most productive uses. |
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