Do Court Delays Distort Capital Formation?

Abstract

We study how longer bankruptcy trials affect the size, structure, and allocation of corporate capital. Exploiting a legal reform that reorganised the judicial districts in Italy, we provide three novel insights into the real and allocational effects of legal institutions. First, poor enforcement of financial contracts leads firms to under-allocate capital in intangible assets. Second, it aggravates misallocation by preventing the optimal allocation of physical and intangible assets towards firms with high capital return. Third, in addition to court delays, our findings shed light on the importance of distance from the court as another source of organizational frictions in bankruptcy.

Keywords: court enforcement, bankruptcy proceedings, corporate intangible capital, misallocation, corporate debt overhang, distance from the court

JEL Classification: E22, G33, K40, O16