Debt Renegotiation and the Properties of Accounting Information: Evidence from a Bankruptcy Reform

Abstract

This paper examines the impact of a Bankruptcy reform that increases the ability to renegotiate debt contracts on timely loss recognition. The legal changes embedded in the reform can decrease debt renegotiation costs, providing firms with incentives to increase timely loss recognition. Empirically, I exploit the introduction of a recent Bankruptcy reform in Italy that substantially facilitated debt renegotiation and court enforcement as a source of variation in firms’ exposure to the Bankruptcy reform. I address endogeneity concerns by relying on discontinuous changes in court enforcement among similar contiguous municipalities located across judicial district borders. I find that after the adoption of the Bankruptcy reform, firms in judicial districts with high levels of enforcement experience a greater increase in timely loss recognition than firms in judicial districts with low levels of enforcement. Cross-sectional analyses support the inferences that the increase in timely loss recognition is driven by lower renegotiation costs. Taken together, this paper provides evidence on how the ability of contracting parties to renegotiate debt contracts affects the timeliness of loss recognition.

Keywords: Debt renegotiation, legal institutions, bankruptcy laws, timely loss recognition.

JEL Classification: G32, G33, G38, K20, M41