Creditor Protection, Ease of Repossession, and the Cost of Equity Capital: Evidence from Quasi-natural Experiments

Abstract

Exploiting the staggered adoption of anti-recharacterization laws across various U.S. states as quasi-exogenous shocks to secured lenders’ ability to repossess assets in bankruptcy, we find that the strengthening of creditor rights is associated with a significant decrease in the cost of equity capital. This effect is more pronounced among firms that are more financially constrained and weakly governed. We further find that the adoption of such laws is associated with lower information asymmetry and lower firm risk. Our overall findings indicate that strengthened creditor protection can lead to a better alignment of the interests of shareholders and creditors through improved financing capacity and creditor monitoring.

Keywords: Cost of Equity Capital, Creditor Protection, Anti-recharacterization Law, Repossession, Corporate Governance

JEL Classification: G32, G34, G38