When Should Bankruptcy Law Be Creditor‐ or Debtor‐Friendly? Theory and Evidence

Abstract

We examine how creditor protection affects firms with different levels of owners' and managers' personal costs of bankruptcy (PCB). Theoretically, we show that firms with high PCB borrow and invest more under a more debtor-friendly management stay system, whereas firms with low PCB borrow and invest more under a more creditorfriendly receivership system. Intuitively, stronger creditor protection relaxes financial constraints but reduces credit demand. Which effect dominates depends on owners' and managers' PCB. Empirically, we find support for these predictions using a Korean bankruptcy reform that replaced receivership with management stay.EMPIRICAL EVIDENCE ON THE OPTIMAL degree of creditor protection in bankruptcy is mixed. Following the seminal work of La Porta et al. (1997Porta et al. ( , 1998, a number of studies document a positive relationship between creditor protection and the size of credit markets, 1 while several recent studies suggest a negative relationship (Acharya and Subramanian (2009), Acharya, Amihud, and Litov (2011), Vig (2013). Given these opposing views, when firms * David Schoenherr is with Princeton University. Jan Starmans is with the Stockholm School of Economics. We thank Amit Seru (Editor), an anonymous Associate Editor; two excellent anonymous referees; as well as Natalie Bachas;

Testing the Impact of Liquidation Speed on Leverage Using Indian Data

“…Our paper contributes to the discussion on the influence of creditor rights on capital structure by considering a previously unresearched channel that complements previous work on other channels such as the bankruptcy risk channel (Schoenherr and Starmans, 2022;Harris and Raviv, 1990) and the liquidation value channel (Vig 2013;Acharya et al, 2011). We further present new findings about creditor rights reforms in India (Kulkarni et al, 2021;Thapa et al, 2020;Vig 2013).…”

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