Creditor rights and corporate risk-taking

Abstract

We analyze the link between creditor rights and firms’ investment policy, proposing that stronger creditor rights in bankruptcy reduce corporate risk-taking. Employing country-level data, we find that stronger creditor rights are associated with a greater propensity of firms to engage in diversifying mergers, and this propensity changes in response to changes in the country creditor rights. Also, in countries with stronger creditor rights, operating risk of firms is lower, and acquirers with low-recovery assets prefer targets with high-recovery assets. These relationships are strongest in countries where management is dismissed in reorganization, suggesting a managerial agency effect. Our results question the value of strong creditor rights, which may have adverse effect on firms by inhibiting them from undertaking risky investments.