This paper measures the cost of sovereign debt crises by focusing on the impact of sovereign risk on firms’ intangible investment and TFP. Using Italian firm-level data, we find that small firms and high-leverage firms significantly reduce their intangible investment during the Italian sovereign debt crisis. High-leverage firms reallocate their resources from intangible capital to tangible capital to offset the tightening of financial conditions because tangible capital can be used as collateral. We analyze these patterns by developing a quantitative model incorporating sovereign default risk, financial intermediations, and firm investment decisions on both tangible and intangible capital. In the model, government default risk deteriorates banks’ balance sheets, disrupting banks’ ability to finance firms. Since firms depend on external funding to cover a fraction of investment, firms – especially small and high-leverage ones – reduce intangible investment, which hurts their future total factor productivity. We estimate the model using Italian data and find that the increase in sovereign risk explains the slow recovery of productivity after the debt crisis through the intangible investment channel.