The Economics of Legal Uncertainty

74 Pages Posted: 22 Nov 2022 Last revised: 24 Oct 2024

See all articles by Jiwon Lee

Jiwon Lee

Princeton University

David Schoenherr

Princeton University, Bendheim Center for Finance; European Corporate Governance Institute (ECGI)

Jan Starmans

Department of Finance, Stockholm School of Economics

Date Written: October 24, 2024

Abstract

 In this paper, we examine how legal uncertainty affects economic activity. We develop a model that distinguishes between two types of legal uncertainty that can impede economic growth: idiosyncratic and systematic legal uncertainty. We test the model's predictions using micro-level data on bankruptcy judges and corporate loans in Korea. To compute time-varying court-level measures of legal uncertainty, we exploit random case assignment to judges and exogenous judge rotations in the judicial system. Our results show that firms tend to file for restructuring in courts with lower levels of legal uncertainty. We also find that higher legal uncertainty leads to smaller credit markets, predominantly for high-risk firms. Our analysis further indicates that credit supply is less sensitive to idiosyncratic legal uncertainty than credit demand, as banks can diversify idiosyncratic legal uncertainty across borrowers.

Keywords: Bankruptcy, law and economics, legal uncertainty, uncertainty.

JEL Classification: G31, G32, G33, G38, K22.

Suggested Citation

Lee, Jiwon and Schoenherr, David and Starmans, Jan, The Economics of Legal Uncertainty (October 24, 2024). European Corporate Governance Institute - Law Working Paper No. 669/2022, Available at SSRN: https://ssrn.com/abstract=4276837 or http://dx.doi.org/10.2139/ssrn.4276837

Jiwon Lee

Princeton University ( email )

Princeton, NJ
United States

David Schoenherr (Contact Author)

Princeton University, Bendheim Center for Finance ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Jan Starmans

Department of Finance, Stockholm School of Economics ( email )

+46 8 736 9181 (Phone)

HOME PAGE: http://sites.google.com/site/janstarmans11/

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