Legal Effectiveness and External Capital: The Role of Foreign Debt
31 Pages Posted: 25 Jul 2004
Date Written: July 2004
Previous research has documented weak, and sometimes conflicting, effects of legal quality on measures of firm debt. Using WorldScope data for 1,689 firms as well as more detailed proprietary data for 315 firms across nine East Asian countries, we find that access to foreign financing appears to loosen borrowing constraints associated with poor legal systems. This helps resolve inconsistencies in prior findings as well as explains how legal protection is important for debt use. In particular, we find that the legal effectiveness is important for determining the amount, the maturity, and the currency denomination of debt. We discuss several mechanisms by which firms can avoid the costs of poor legal systems with foreign borrowing. Finally, this paper contributes to the policy debate surrounding the importance of creditor rights for domestic lending.
Keywords: Foreign currency debt, legal origin
JEL Classification: F34, G32
Suggested Citation: Suggested Citation