Working Paper: NBER ID: w9949
Authors: Eric Friedman; Simon Johnson; Todd Mitton
Abstract: In countries with weak legal systems, there is a great deal of tunnelling by the entrepreneurs who control publicly traded firms. However, under some conditions entrepreneurs prop up their firms, i.e., they use their private funds to benefit minority shareholders. We provide evidence and a model that explains propping. In particular, we suggest that issuing debt can credibly commit an entrepreneur to propping, even though creditors can never take possession of any underlying collateral. This helps to explain why emerging markets with weak institutions sometimes grow rapidly and why they are also subject to frequent economic and financial crises.
Keywords: No keywords provided
JEL Codes: G33; P12; K12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| increased debt (H63) | propping (Y60) |
| increased debt (H63) | reduced incentive for expropriation (H13) |
| increased debt (H63) | increased firm value (G32) |
| higher propensity for propping (E71) | increased debt (H63) |
| higher propensity for propping (E71) | mitigated adverse effects of debt on stock prices (G32) |
| weaker corporate governance (G38) | higher ratio of debt to total assets (G32) |
| weak legal protections (P14) | increased tunneling (R42) |
| weak legal protections (P14) | increased propping (Y60) |