The Bright Side of Foreign Competition: Import Penetration and Default Risk

Abstract

We examine the effect that foreign competition has on firms’ default risk, and document a strong and robust negative association. Utilizing a large sample of public U.S. manufacturing firms and industry-level import penetration data, we find that an increase in import penetration from the 25th to the 75th percentile leads to a reduction in corporate default risk of roughly 3%. These results hold after accounting for potential endogeneity concerns. We also document a negative association between import penetration and credit default swap spreads and the incidence of bankruptcies. Further tests reveal that the negative association between import penetration and default risk is driven by foreign competition promoting lower return volatility. Our paper contributes to the ongoing discourse on the costs and benefits of trade liberalization, documenting the ‘bright side’ of foreign competition.

Keywords: Expected default risk; Foreign competition; Corporate Governance

JEL Classification: G15; G33; G34