Bankruptcy Codes and Innovation
Subject
Finance
Publishing details
Publication Year
2007
Abstract
Do legal institutions governing financial contracts affect the nature of real investments in the economy? We provide evidence that the answer to this question is yes. We argue that when the bankruptcy code is creditor-friendly, excessive liquidations cause levered firms to shy away from innovation. In contrast, by promoting continuation upon failure, a debtor-friendly code induces greater innovation. Employing patents as a proxy for innovation, we find support for the real as well as financial implications of this effect of bankruptcy codes on real investments: (1) In countries with weaker creditor rights, technologically innovative industries create disproportionately more patents and these patents also generate disproportionately more citations relative to other industries; (2) Time-series changes in creditor rights within a country confirm this difference-of-difference result as well as the direct effect of creditor rights on the absolute level of innovation, suggesting a causal effect of bankruptcy codes on innovation; (3) When creditor rights are stronger, innovative industries employ relatively less leverage compared to other industries; and (4) In countries with weaker creditor rights, technologically innovative industries grow disproportionately faster compared to other industries.
Keywords
Creditor rights; R&D; Technological change; Law and finance; Entrepreneurship; Growth; Financial development
Publication Research Centre
Institute of Finance and Accounting
Series Number
FIN 463
Series
IFA Working Paper
Available on ECCH
No
