Determinants of Financial Insolvency Costs: New Evidence from International Data

Abstract

This study examines the determinants of financial insolvency costs, by making use of a more accurate indicator of the probability of insolvency and considering the effect of institutional differences on these costs. We find that insolvency costs are positively related to the probability of financial insolvency, and negatively related to leverage and the holding of liquid assets. Insolvency costs increase with underinvestment processes, which in turn emerge as a consequence of the high probability of financial insolvency. Employment reductions are also a widespread practice for reacting to the crisis, even though the effect of this policy on insolvency costs depends on institutional differences. Finally, the sensitivity of insolvency costs to the probability of financial insolvency, leverage and the holding of liquid assets depends on the institutional context as well.

Keywords: Financial distress, insolvency costs, leverage, investment, employment

JEL Classification: G33