CREDITOR RIGHTS, COST OF EQUITY CAPITAL AND DEBT CAPACITY: EVIDENCE FROM A QUASI EXPERIMENT

Abstract

Using the difference-in-difference approach, we find that the staggered enactment of anti-recharacterization laws, which strengthened creditor rights by enhancing the ability of creditors to repossess collateral during bankruptcy, leads to lower cost of equity capital of the treated firms. We explore the underlying mechanism and find that this new evidence is present only in financially constrained firms. Further, the most impacted firms are those that enter the shock period with more need of external financing and those with post-shock increase in debt financing and debt maturity. We also find that increased institutional holdings and improved information quality (i.e. a decrease in analysts forecast dispersion) are channels through which stronger creditor rights decrease the coast of equity financing. Our findings provide supportive ground to the introduction of laws or regulations that strengthen the rights of other stakeholders.