This paper empirically investigates the role of the efficiency of judicial enforcement in shaping firmsÂ’ financial structure, by focusing on the choice between trade credit and alternative external sources. Suppliers have an advantage over other short-term lenders in enforcing credit contracts, thus being less dependent on the institutional mechanisms for the protection of creditor rights. Trade credit represents in-kind finance: in contrast with other investors, who lend cash, suppliers lend inputs. Being illiquid, inputs are less easily diverted than cash, hence trade credit providers are less subject to moral hazard problems than other creditors. As a consequence, in countries where creditor protection is weaker the importance of trade credit compared to bank credit should be greater, especially when asymmetric information problems are more significant. The issue is analysed by using information on firm-specific characteristics and on the local structure of the manufacturing, of the banking and of the judicial sector over the period 1995-1998. The empirical evidence highlights the importance of judicial enforcement for corporate finance choices: in areas characterised by a lower degree of judicial enforcement, firms use more trade credit compared to alternative short-term sources. The effects vary according to firmsÂ’ characteristics such as their credit-worthiness and the average cost of funds.
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Find related papers by JEL classification: G3 - Financial Economics - - Corporate Finance and Governance K4 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior
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