Creditor rights, bank monitoring, and corporate risk-taking: evidence from creditor rights reform

This study examines whether creditor rights can substitute for bank monitoring in influencing corporate risk-taking. We explore the contrasting objectives of government-owned banks (GOBs) and privately owned banks (POBs) to assess the intensity of bank monitoring. Additionally, we exploit a regulatory intervention as an exogenous shock to creditor rights, likely increasing borrowers’ liquidation risk. We hypothesize that firms borrowing from GOBs, which typically engage in less rigorous monitoring, may face increased liquidation risks after a regulatory intervention that strengthens creditor rights. This, in turn, could lead to reduced corporate risk-taking. Using difference-in-differences methods, our empirical analysis strongly supports this hypothesis. Furthermore, the findings suggest that reduced corporate risk-taking improves firm performance. The study underlines the pivotal roles of creditor rights and bank monitoring in shaping corporate behaviour and contributes to the literature on GOB corporate risk-taking and liquidation risk through a quasi-natural experiment involving an increase in creditor rights.