Investment complementarities, coordination failure, and systemic bankruptcy

This paper studies systemic bankruptcy in an economy where: (i) investment complementarities exist; (ii) firms have heterogeneous information about investment returns; and (iii) firms need to finance their investments by borrowing from outside lenders. In a global game setup, I demonstrate that even a small uncertainty about economic fundamentals can be magnified through the uncertainty about other firms' investment decisions, and can lead to coordination failure, which may be manifested as systemic bankruptcy. Moreover, my model reveals that systemic bankruptcy tends to arise when economic fundamentals are in the intermediate range where coordination matters. High financial leverage of firms greatly increases the severity of systemic bankruptcy. Optimistic beliefs of firms and lenders can alleviate coordination failure, but can also increase the severity of systemic bankruptcy once it happens. High financing costs of lenders worsen coordination failure and increase the severity of systemic bankruptcy by increasing firms' debt burden. Copyright 2013 Oxford University Press 2012 All rights reserved, Oxford University Press.