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Creditor rights and corporate risk-taking

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  • Viral V. Acharya
  • Yakov Amihud
  • Lubomir Litov

Abstract

We analyze the link between creditor rights and firms’ investment policies, proposing that stronger creditor rights in bankruptcy reduce corporate risk-taking. In cross-country analysis, we find that stronger creditor rights induce greater propensity of firms to engage in diversifying acquisitions, which result in poorer operating and stock-market abnormal performance. In countries with strong creditor rights, firms also have lower cash flow risk and lower leverage, and there is greater propensity of firms with low-recovery assets to acquire targets with high-recovery assets. These relationships are strongest in countries where management is dismissed in reorganization, and are observed in time-series analysis around changes in creditor rights. Our results question the value of strong creditor rights as they have an adverse effect on firms by inhibiting management from undertaking risky investments.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 15569.

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Date of creation: Dec 2009
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Handle: RePEc:nbr:nberwo:15569

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