Debt enforcement and bank loans: evidence from insolvency practices worldwide

ABSTRACT

Using a novel debt enforcement index reflecting legal and economic characteristics directly relating to resolving insolvency across the world, we document that bank loan terms are more stringent (larger interest rate spread, higher collateral requirement, more covenants) in countries with weaker debt enforcement. The effect is more prominent when creditor rights are better protected and debtors are exposed to higher fundamental and informational risks. Improved enforcement has real effects of reducing borrowers’ covenant violation and enhancing their preference for bank funding. Lenders’ syndicates become more concentrated as loan contract enforceability deteriorates. A difference-in-differences analysis of insolvency resolution reforms worldwide confirms the cross-country evidence.

KEYWORDS:

• Debt enforcement
• insolvency practice
• bank loan contracting

Acknowledgments

This article is based on a paper that received the “Best Paper” award at the 8th conference of the World Accounting Frontiers Series (WAFS). Chong Wang acknowledges research supports from the Social Science Youth Program of Fujian Province (No. FJ2018C036) and School of Accounting and Finance, Hong Kong Polytechnic University. Yanchao Wang acknowledges research support from the Natural Science Foundation of China (No. 71972194). Feng (Harry) Wu acknowledges research support from Department of Accountancy, Faculty of Business, Lingnan University. All errors are our own.

Disclosure statement

No potential conflict of interest was reported by the authors.

Correction Statement

This article has been republished with minor changes. These changes do not impact the academic content of the article.

Notes

1. https://epub.prsgroup.com/list-of-all-variable-definitions.

2. http://info.worldbank.org/governance/wgi/pdf/rl.pdf.

3. We present evidence in the robustness tests that our results are not driven by this weighted regression estimation technique or by the dominating number of observations from the U.S.

4. Our sample period ends in 2009, similar to Favara et al. (2017) who also adopt a DHMS-based enforcement measure. The main reason is that we follow the common practice in the literature and use the 2011 version of Chava and Roberts (2008) link table for matching bank loan data from Deal Scan with accounting data from Compustat Global. The latest year that is fully covered by this link table is 2009.

5. For the convenience of exposition, we use countries to refer to the jurisdictions used in this paper.

6. We find consistent results when we use Creditor Rights as the conditioning variable.

7. Bae and Goyal (2009) assess syndicate concentrations in different property rights groups without controlling for other variables. Consequently, their finding can at best be considered as indirect evidence.