In this paper we study the effect of credit market disruptions on real decisions in a firm. We use firm-level data on employment for a sample of Iranian public firms. We construct a new hand-collected dataset on bank-firm relationship. As for the source of credit supply disruption, we use the 2011 Iranian banking fraud that impacted the credit access for connected firms. Using a difference in difference approach, we compare how employment is affected by credit supply for the impacted firms (connected to a troubled bank) vs. non-impacted ones (connected to a non-troubled bank). Our findings show that a sudden dry up in the credit supply channel is followed by a drop in employment, especially in smaller and more financially constrained firms. Our results highlight the importance of the credit supply channel and the hidden costs of financial scandals on the real side of the economy.
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