Debt enforcement,investment, and risk taking across countries |
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| Authors: | Giovanni Favara Erwan Morellec Enrique Schroth Philip Valta |
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| Affiliation: | 1. Division of Monetary Affairs, Board of Governors of the Federal Reserve System, Washington, DC 20551, USA;2. Ecole Polytechnique Fédérale de Lausanne, Extranef 210, Lausanne, Switzerland;3. Finance Faculty, Cass Business School, City University London, 106 Bunhill Row, London EC1Y 8TZ, UK;4. University of Bern, Engehaldenstrasse 4, Bern 3012, Switzerland;5. University of Geneva, 1211 Geneva, Switzerland;6. Swiss Finance Institute, Boulevard du Pont d''Arve, Geneva, Switzerland;7. CEPR, London EC1V 0DX, United Kingdom |
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| Abstract: | We argue that the prospect of an imperfect enforcement of debt contracts in default reduces shareholder–debtholder conflicts and induces leveraged firms to invest more and take on less risk as they approach financial distress. To test these predictions, we use a large panel of firms in 41 countries with heterogeneous debt enforcement characteristics. Consistent with our model, we find that the relation between debt enforcement and firms’ investment and risk depends on the firm-specific probability of default. A differences-in-differences analysis of firms’ investment and risk taking in response to bankruptcy reforms that make debt more renegotiable confirms the cross-country evidence. |
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| Keywords: | Debt enforcement Default Investment Asset sales Risk-taking G31 G32 G33 |
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