Government late payments and firms survival. Evidence from the EU

Outstanding payments in commercial transactions, if delayed beyond the agreed period of time, can engender a range of negative externalities, exposing firms to severe liquidity risks. In this study we examine to what extent stricter regulations facing payment backlogs, brought about by the EU directive on Late Payment have affected firms performance. We focus on government-to-business activities and on the firms’ response to the introduction of these regulations. Our evidence suggests that, as a result of the directive, the firms’ exit rate has fallen relatively more in those sectors that sell a larger fraction of their output to the government. We document more pronounced effects in sectors with a large share of small firms and for countries characterized by longer payment delays. Further results show that the adoption of the directive has been associated with an increase in employment in those sectors more connected with the government. Taken together, our findings indicate that more discipline in government’s payment terms can have considerable effects on economic activity