Do Court Delays Distort Capital Formation?
60 Pages Posted: 8 Jul 2020 Last revised: 20 Jul 2020
Date Written: July 17, 2020
Weak enforcement of financial contracts often distorts the incentive to invest and delays efforts to catch up with the technology frontier. We study how longer bankruptcy trials affect the size, structure and allocation of corporate capital across different regions in Italy. We take advantage of an exogenous change in local courts’ efficiency caused by the reorganization of judicial districts under the legislative reform of 2012. Using an instrumental variable strategy, we find that the change in length of bankruptcy proceedings had a strong impact on firm-level outcomes. Our estimates show that the interquantile reduction in the length of bankruptcy trials increases the firm’s capital stock and capital intensity of production by 9.7% to 11.5%. Significantly, our results provide two novel findings on financial market effects of legal institutions. Fist, we find that poor enforcement of financial contracts leads firms to under-allocate capital in their intangible assets. Second, our results show that court delays exacerbate misallocation by preventing the optimal allocation of physical and intangible assets towards firms with high capital return.
Keywords: court enforcement, bankruptcy proceedings, corporate intangible capital, misallocation, corporate debt overhang
JEL Classification: E22, G33, K40, O16
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