Research

This paper examines the conditions under which temporary cash flow shocks on firms can generate lasting scarring effects. If adverse weather conditions force the interruption of work, contractual payments to the firms assigned to the project are delayed. This impairs their short-term liquidity position. Concurrently, firms cannot fully reduce their labour and capital costs, since they may have to suddenly resume work when the interruption is lifted. This is the liquidity shortfall I quantify using data on Italian construction firms and on their infrastructure projects, obtained from a new database on the universe of public procurement contracts in the country. I isolate the effects of the cash flow shock through a staggered DiD design matching similar firms.

Work interruptions lead to extensive financial damage, with sales dropping on average by 30%, employment by 15.3%, and total assets by 18.5% in the years after a firm is first hit. The negative effects persist for up to five years after the end of the work interruption itself. In other words, temporary liquidity shocks can have persistent, scarring effects. The magnitude and persistence of the adverse effects of cash flow shocks are not driven primarily by interrupted projects, which are directly hit by adverse weather, but rather by the knock-on effects on firms' other projects, which are not hit directly, and yet which also exhibit completion and thus payment delays, as liquidity-constrained firms struggle to cover their running costs.