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Debt Enforcement, Investment, and Risk Taking Across Countries

49 Pages Posted: 10 Jan 2014 Last revised: 15 Sep 2016

Giovanni Favara

Federal Reserve Board

Erwan Morellec

Ecole Polytechnique Fédérale de Lausanne; Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne

Enrique J. Schroth

City University London - Cass Business School

Philip Valta

University of Bern; University of Geneva; Swiss Finance Institute

Date Written: March 3, 2016

Abstract

We argue that the prospect of an imperfect enforcement of debt contracts in default reduces shareholder-debtholder conflicts and induces leveraged firms to invest more and take on less risk as they approach financial distress. To test these predictions, we use a large panel of firms in 41 countries with heterogeneous debt enforcement characteristics. Consistent with our model, we find that the relation between debt enforcement and firms' investment and risk depends on the firm-specific probability of default. A difference-in-differences analysis of firms' investment and risk taking in response to bankruptcy reforms that make debt more renegotiable confirms the cross-country evidence.

Keywords: Debt renegotiation, Default; Investment , Asset sales, Risk-taking

JEL Classification: G31, G32, G33

Suggested Citation

Favara, Giovanni and Morellec, Erwan and Schroth, Enrique J. and Valta, Philip, Debt Enforcement, Investment, and Risk Taking Across Countries (March 3, 2016). Journal of Financial Economics (JFE), Forthcoming; Swiss Finance Institute Research Paper No. 13-64. Available at SSRN: https://ssrn.com/abstract=2377253 or http://dx.doi.org/10.2139/ssrn.2377253

Giovanni Favara

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

HOME PAGE: http://www.giovannifavara.com

Erwan Morellec

Ecole Polytechnique Fédérale de Lausanne ( email )

College of Management
Extranef Quartier UNIL-Dorigny
1015 Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/

Ecole Polytechnique Fédérale de Lausanne - Ecole Polytechnique Fédérale de Lausanne ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Enrique J. Schroth

City University London - Cass Business School ( email )

London, EC2Y 8HB
Great Britain

Philip Valta (Contact Author)

University of Bern ( email )

Engehaldenstrasse 4
Bern, 3012
Switzerland

University of Geneva ( email )

Bd. du Pont d'Arve 40
Geneva, 1211
Switzerland

Swiss Finance Institute ( email )

c/o University of Geneva
Bd du Pont-d'Arve 40
Geneva, 1211
Switzerland

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