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An agency cost channel from creditor rights reforms to leverage

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  • Banerjee, Biswajit
  • Herrala, Risto

Abstract

The paper investigates the influence of creditor rights reforms on leverage. Based on a partial equilibrium agency cost model, we propose a novel channel running from the owner/manager's private bankruptcy costs to leverage. Such costs mitigate the firms' agency problem toward creditors, thereby increasing credit limits and leverage. The proposition is tested with data from India 2011-2020, a period that saw the strengthening of creditor rights. We find that the reform caused leverage to fall, which is indicative of a decrease in owner/manager's bankruptcy costs. We also find evidence of a decline in credit limits as predicted by the proposed theory.

Suggested Citation

  • Banerjee, Biswajit & Herrala, Risto, 2025. "An agency cost channel from creditor rights reforms to leverage," BOFIT Discussion Papers 6/2025, Bank of Finland Institute for Emerging Economies (BOFIT).
    • Handle: RePEc:zbw:bofitp:323947
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    JEL classification:

    • C21 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Cross-Sectional Models; Spatial Models; Treatment Effect Models
    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • K35 - Law and Economics - - Other Substantive Areas of Law - - - Personal Bankruptcy Law

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