Working Paper: CEPR ID: DP6697
Authors: Viral V. Acharya; Yakov Amihud; Lubomir P. Litov
Abstract: We propose that stronger creditor rights in bankruptcy reduce corporate risk-taking. Employing country-level data, we find that strong creditor rights are associated with a greater propensity of firms to engage in diversifying mergers, and this propensity changes in response to changes in the country creditor rights. Also, in countries with stronger creditor rights companies? operating risk is lower, and acquirers with low-recovery assets prefer targets with high-recovery assets. These relationships are strongest in countries where management is dismissed in reorganization, suggesting an agency-cost effect. Our results suggest that there might be a "dark" side to strong creditor rights in that they can induce costly risk avoidance in corporate policies. Thus, stronger creditor rights may not necessarily be optimal.
Keywords: bankruptcy; default; diversification; managerial turnover; recovery
JEL Codes: G31; G32; G33; G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Stronger creditor rights (G33) | Greater propensity for firms to engage in diversifying mergers (G34) |
| Stronger creditor rights (G33) | Lower operating risk (G32) |
| Stronger creditor rights (G33) | Lower likelihood of same-industry mergers (L19) |
| Stronger creditor rights (G33) | Increased likelihood of acquiring high-recovery asset targets in low-recovery asset industries (G33) |