An agency cost channel from creditor rights reforms to leverage
Banerjee, Biswajit; Herrala, Risto (08.08.2025)
Numero
6/2025Julkaisija
Bank of Finland
2025
Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi-fe2025080881815Tiivistelmä
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.
Julkaisuhuomautus
NON-TECHNICAL SUMMARY
FOCUS
Creditor rights reforms (CRRs) can markedly influence corporate finance and may even have implications for economic development and financial stability. Previous work has established that CRRs influence corporate borrowing via various channels. There is significant evidence that an increase in the liquidation value of firms contributes to increased firm debt. Furthermore, changes in the bankruptcy costs borne by the manager and the owner of the firm are known to influence credit demand. In the present study, we revisit the issue theoretically and empirically to uncover previously undiscussed impact channels.
CONTRIBUTION
Based on a partial equilibrium agency cost model, the paper proposes the existence of an “agency cost channel” running from the private bankruptcy costs of the manager/owner of the firm, via credit limits, to firm borrowing and leverage. Theoretically, an increase in such costs mitigates agency problems between the firm and its creditors, thereby improving the credit availability of the firm. We test our proposed agency cost channel with a case study of India’s Insolvency and Bankruptcy Code (IBC) of 2016.
FINDINGS
Using a difference-in-differences model, we find that the IBC contributed to a fall in leverage. In accordance with our proposed theory, the negative overall impact validates the existence of an agency cost channel. We also detect a lowering of credit limits as predicted by our theory.
FOCUS
Creditor rights reforms (CRRs) can markedly influence corporate finance and may even have implications for economic development and financial stability. Previous work has established that CRRs influence corporate borrowing via various channels. There is significant evidence that an increase in the liquidation value of firms contributes to increased firm debt. Furthermore, changes in the bankruptcy costs borne by the manager and the owner of the firm are known to influence credit demand. In the present study, we revisit the issue theoretically and empirically to uncover previously undiscussed impact channels.
CONTRIBUTION
Based on a partial equilibrium agency cost model, the paper proposes the existence of an “agency cost channel” running from the private bankruptcy costs of the manager/owner of the firm, via credit limits, to firm borrowing and leverage. Theoretically, an increase in such costs mitigates agency problems between the firm and its creditors, thereby improving the credit availability of the firm. We test our proposed agency cost channel with a case study of India’s Insolvency and Bankruptcy Code (IBC) of 2016.
FINDINGS
Using a difference-in-differences model, we find that the IBC contributed to a fall in leverage. In accordance with our proposed theory, the negative overall impact validates the existence of an agency cost channel. We also detect a lowering of credit limits as predicted by our theory.