Creditor Rights and Corporate Risk-Taking
61 Pages Posted: 17 Apr 2008 Last revised: 1 Dec 2009
Date Written: April 6, 2009
We analyze the link between creditor rights and firms’ investment policies, proposing that stronger creditor rights in bankruptcy reduce corporate risk-taking. In cross-country analysis, we find that stronger creditor rights induce greater propensity of firms to engage in diversifying acquisitions, which result in poorer operating and stock-market abnormal performance. In countries with strong creditor rights, firms also have lower cash flow risk and lower leverage, and there is greater propensity of firms with low-recovery assets to acquire targets with high-recovery assets. These relationships are strongest in countries where management is dismissed in reorganization, and are observed in time-series analysis around changes in creditor rights. Our results question the value of strong creditor rights as they have an adverse effect on firms by inhibiting management from undertaking risky investments.
Keywords: bankruptcy, international finance, corporate governance, investment policy
JEL Classification: G33, K12, G31, G24, D82
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