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Debt Enforcement, Investment, and Risk Taking Across Countries

Author

Listed:
  • Giovanni Favara

    (Federal Reserve Board)

  • Erwan Morellec

    (Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute)

  • Enrique J. Schroth

    (City University London)

  • Philip Valta

    (University of Geneva and Swiss Finance Institute)

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 difference-in-differences analysis of firms' investment and risk taking in response to bankruptcy reforms that make debt more renegotiable confirms the cross-country evidence.

Suggested Citation

  • Giovanni Favara & Erwan Morellec & Enrique J. Schroth & Philip Valta, 2013. "Debt Enforcement, Investment, and Risk Taking Across Countries," Swiss Finance Institute Research Paper Series 13-64, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1364
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    File URL: http://ssrn.com/abstract=2377253
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    Keywords

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    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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