Banking Relationships and Creditor Rights
Forthcoming, Quarterly Journal of Finance, Vol. 9. No. 4, 2019
40 Pages Posted: 25 Oct 2019
Date Written: August 5, 2019
Do the legal rights of creditors influence whether firms borrow from arm’s length or relationship lenders in a country? We examine this question by exploiting the staggered adoption of legal reforms that changed creditor rights. We find that as creditor rights strengthen, firms exhibit a greater propensity to switch to relationship lenders. Conversely, firms switch to arm’s length lenders as creditors rights weaken. These results are consistent with the view that arm’s length creditors have a bias towards excessive liquidation in environments with strong creditor rights. Hence as creditor rights strengthen, firms switch to relationship lenders as they are less likely to sub-optimally liquidate the firm when continuation is more efficient.
Keywords: banking relationships, creditor rights, liquidation bias, arm’s length creditors
JEL Classification: D23, G21, G32, K42
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