Firms’ Financing, Contract Enforcement, and Liability Dollarization

8 Pages Posted: 12 Apr 2010 Last revised: 12 Mar 2012

See all articles by César Sosa-Padilla

César Sosa-Padilla

McMaster University - Faculty of Social Sciences

Date Written: March 1, 2010

Abstract

This paper analyzes how the presence of liability dollarization, different degrees of contract enforcement, and the possibility to default on debts affect firms’ financing decisions. The framework is a dynamic model of heterogeneous firms. They finance their capital acquisitions using their own income and borrowing from foreign lenders. The set of contracts available incorporates the possibility of default. The incentives to repay or default are determined by the firms’ value relative to the value of default, controlled by the degree of contract enforcement and the presence of liability dollarization. Quantitative evidence is found to support the common wisdom that firms in economies subject to liability dollarization are more likely to default. The presence of liability dollarization increases the likelihood of default by 13%. Weak contract enforcement increases the probability of default by almost 19%. Default regions are determined, with small, highly leveraged firms being more prone to default.

Keywords: Liability Dollarization, Contract Enforcement, Firm Default, Emerging Economies

Suggested Citation

Sosa-Padilla, César, Firms’ Financing, Contract Enforcement, and Liability Dollarization (March 1, 2010). Journal of CENTRUM Cathedra, Vol. 3, Issue 1, pp. 10-17, 2010. Available at SSRN: https://ssrn.com/abstract=1588170

César Sosa-Padilla (Contact Author)

McMaster University - Faculty of Social Sciences ( email )

Canada

HOME PAGE: http://sites.google.com/site/cesarsosapadilla/

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