Creditor rights, lender competition and firm value

Abstract

We show that the real effects of creditor rights critically depend on the degree of lender competition. To do this, we introduce both lender market power and limited pledgeability of cash flows in an otherwise standard moral hazard problem. The degree of competition does not affect entry at the extensive margin, or the optimality of issuing debt. However, the extent of competition affects the intensive margin. Specifically, with competing lenders, creditor rights relax a firm's financing constraint, inducing higher firm value. In sharp contrast, with market power, creditor rights can reduce both effort and firm value, while increasing lender profit. This lender-competition channel can reconcile the limited, or even negative, effects of creditor rights reforms in developing economies.

Keywords: Creditor rights, Lender competition, Secured debt, Formalization, Titling reforms, De Soto effect JEL classification: G21, G32, G33, G38