can bankruptcy laws mitigate business cycles? evidence from … · 2014. 5. 7. · bernanke and...

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Can Bankruptcy Laws Mitigate Business Cycles? Evidence from

Creditor Rights, Debt Financing, and Investment

Yaxuan Qi, Lukas Roth, and John K. Wald*

October 23, 2013

Abstract We examine how legal creditor rights affect investment and financing over the business cycle. Using firm-level data from 40 countries, we find that creditor rights play an important role in increasing investment and debt financing during economic downturns, but have little impact during expansions. We also find that the negative relation between creditor rights and the cost of debt is concentrated during recessions. The beneficial effects of creditor rights are stronger for firms that are more likely to have severe shareholder-bondholder agency problems. Overall, the results suggest that better creditor protection laws help moderate the decline in investment and debt financing during recessions. Keywords: Business Cycles, Agency Costs, Creditor Rights, Investment, Debt

Financing JEL Codes: E02, E32, F44, G31, G32

* Yaxuan Qi is at the City University of Hong Kong, [email protected]; Lukas Roth is at the University of Alberta, [email protected]; and John K. Wald is at the University of Texas at San Antonio, [email protected]. We thank Christopher James, David McLean, Todd Mitton, David Reeb, Philip Valta, Andrey Ukhov, Mengxin Zhao, and seminar participants at the City University of Hong Kong, Rensselaer Polytechnic Institute, and Texas State University for helpful suggestions. We are grateful to the Social Sciences and Humanities Research Council of Canada for financial support.

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1. Introduction

Fluctuations in investment are an important driver of business cycles.1 Specifically, the

biggest source of variation in GDP is changes in gross investment, and the biggest source of

fluctuations in gross investment is business capital investment. By better understanding the

determinants that impact corporate investment across the business cycle, we aim to identify

which factors can moderate the decline in lending and investment during recessions. Specifically,

we identify creditor rights as one mechanism which can reduce agency problems in recessions

and therefore mitigate the decline in debt financing and investment which follows a negative

economic shock.

A substantial theoretical literature (Bernanke and Gertler, 1989; Carlstrom and Fuerst,

1997; and Kiyotaki and Moore, 1997) considers how agency problems can amplify economic

shocks and consequently worsen economic contractions. In these models, during economic

downturns, firms’ net worth deteriorates and the “cost of state verification” (Townsend, 1979)

soars. This exacerbates frictions in the external capital markets and leads to an increase in the

expected agency costs between borrowers and lenders, making it more difficult for firms to raise

capital for their investments. Thus, economic downturns deteriorate net worth, increase agency

costs, and decrease investment, which further amplifies the recession. This theoretical literature

suggests that if a particular institutional factor can mitigate agency costs, firms subject to these

better institutions will suffer a smaller decrease in debt financing and investment during

recessions.

We focus on creditor protection laws as a prior literature shows that stronger creditor

protection is associated with greater availability of credit, a lower cost of debt, and a longer debt

1 For instance, Krugman and Wells (2012, p. 753) write, “Although consumer spending is much larger than investment spending, booms and busts in investment spending tend to drive the business cycle. In fact, most recessions originate as a fall in investment spending.”

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maturity (see Djankov, McLiesh, and Shleifer, 2007; Qian and Strahan, 2007; and Bae and

Goyal, 2009). Thus, we hypothesize that stronger creditor protection laws mitigate agency

problems during recessions, and that these laws allow for greater credit availability during

economic downturns.2 Moreover, the existing theory suggests that the relation between creditor

protection and investment and debt financing will be strongest for firms with high expected

agency costs.

Our study is also broadly related to the literature which shows that legal investor

protection contributes to financial market development and economic growth by improving

firms’ access to external financing (see, e.g., La Porta, Lopez-de-Silanes, Shleifer, and Vishny,

1997, 1998; Demirguc-Kunt and Maksimovic, 1998, 1999; and Castro, Clementi, and

MacDonald, 2004). However, this existing literature does not examine whether the effects of

legal investor protections differ over the business cycle. Thus, to our knowledge, this is the first

paper to examine the differential impact of legal institutions, and specifically creditor protections,

over the business cycle.

Our primary analysis is a firm-level study for a large sample of firms from 40 countries

during expansions and recessions. We define a time period as including a recession if any two

consecutive quarterly real GDP growth rates were negative during the year. Alternatively, we

use the real GDP annual growth rate during the year as a proxy for macroeconomic conditions.

To measure creditor protection in a country we use the creditor rights index obtained from

2 An alternative possibility is that weaker creditor protection laws may be associated with greater investment during recessions, as countries with weak creditor rights favor debt forgiveness. This debt forgiveness could lead to greater risk taking by firms and thus greater investment. Such a finding would be consistent with Acharya and Subramanian (2009), who show that greater creditor rights imply lower innovation, and Acharya, Amihud, and Litov (2011) who find reduced risk-taking for companies in greater creditor rights regimes.

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Djankov, McLiesh, and Shleifer (2007). This index is compiled for each year from 1978 to 2003

and ranges from zero to four with higher scores corresponding to stronger creditor protection.

We consider how debt financing changes during recessions with differences in creditor

rights, and we find that greater creditor rights are associated with a significant increase in debt

financing during recessions. However, creditor rights are not significantly associated with debt

financing during expansions. A one unit increase in creditor rights implies 52% greater debt

financing as a fraction of total assets during recessions.

Additionally, we consider the relation between creditor rights and the cost of debt during

recessions and expansions. We find that the negative relation between creditor rights and debt

yields primarily holds during recessions. Thus, better creditor rights help firms to access debt

markets in recessions, and this suggests a greater potential investment for firms in stronger

creditor protection countries during economic downturns. Existing papers (Qian and Strahan,

2007; and Bae and Goyal, 2009) show that the cost of debt is lower for companies in high

creditor rights regimes. We show that these relations are more pronounced during recessions.

Thus, consistent with our other results, bond yields increase less during recessions for firms in

countries with strong creditor protection, suggesting that strong creditor rights moderate bond

yield variations over the business cycle.

We also examine the relation between creditor rights and firm investment over the

business cycle, and we find that stronger creditor rights are positively associated with investment

in recessions but not significantly related to investment during expansions. Comparing recessions

to expansions, a one unit increase in creditor rights implies an increase of 7.6% in capital

expenditures as a fraction of total assets during recessions. This finding supports the notion that

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creditor rights help mitigate the increased agency problems which occur during recessions, and

that the economic magnitude of this effect is sizable.3

If creditor rights matter during recessions because of increased agency costs, then we

expect that firms with larger expected agency problems will be more impacted by differences in

creditor protection laws. To test this proposition, we split the sample into firms which are

expected to have more or fewer agency problems, and we proxy for expected agency problems

using firm leverage and revenue.4 Repeating our analysis for these subsamples, we find that the

impact of creditor rights in recessions is more pronounced for firms with more severe expected

agency conflicts.

These empirical tests are consistent with an increase in agency conflicts between

bondholders and stockholders during recessions. To further examine whether the agency cost of

debt indeed increases in recessions, we graphically examine the use of bond covenants in

corporate bonds during recessions and expansions.5 Bond covenants are used to mitigate agency

problems, and firms with greater bondholder-shareholder agency problems are more likely to use

bond covenants. 6 We find that firms with better bond ratings use more covenants during

recessions than expansions, whereas firms with very weak bond ratings do not issue debt at all

during recessions. These results suggest that agency costs increase during recessions, and that

firms with most severe agency problems are shut out of the credit markets during economic

downturns altogether.

3 We also examine whether these laws affect equity issuance or cash holdings over the business cycle. We find no effects on either equity or cash holdings. 4 Note that given the theory, we focus on shareholder-bondholder agency problems rather than on manager-shareholder or majority-minority owner agency issues. As we discuss below, this theory is reflected in the empirical findings. 5 For this analysis, we only use U.S. corporate bonds, as detailed covenant information for non-U.S. bonds is scarce. 6 See, for instance, Smith and Warner (1979), Malitz (1986), Begley and Feltham (1999), Nash, Netter, and Poulsen (2003), Billett, King, and Mauer (2007), and Qi, Roth, and Wald (2011).

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Our study contributes to the literature as follows. First, we show that stronger creditor

protection laws imply a smaller decrease in debt financing and investment during recessions.

This empirical evidence is consistent with the implications of theoretical models such as

Bernanke and Gertler (1989) and others. In sum, our results support the notion that agency costs

vary with business cycles, and thus, creditor protection is more important in recessions than in

expansions. Second, our study extends the law and finance literature by showing how creditor

protection laws influence firms’ debt financing and investment behavior differently during

recessions than expansions. Third, our results complement a recent literature that studies how

business cycles affect external financing and firm investment (see, e.g., Erel, Julio, Kim, and

Weisbach, 2012; and McLean and Zhao, 2012). These papers along with ours emphasize the

importance of considering the impact of macroeconomic conditions in examining corporate

behavior.

The remainder of the paper proceeds as follows. Section 2 provides a review of the

relevant literature and develops our hypotheses. Section 3 discusses the data and methods

employed by this study. Section 4 presents the results of our empirical tests, and section 5

concludes.

2. Related Literature and Research Design

Our paper is partly motivated by the macroeconomic literature that provides a theory of

how agency problems can alter business cycles. Bernanke and Gertler (1989) show that increased

agency problems due to deteriorating net worth can lead to higher costs of external finance,

decrease the firm’s ability to obtain financing, and therefore decrease investment and further

deepen the economic contraction. Carlstrom and Fuerst (1997) extend this model to show how

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these dynamics can explain the observed positive autocorrelation in output growth. Additionally,

Kiyotaki and Moore (1997) show that if durable assets serve as collateral for loans, a small shock

can reduce the ability of firms to get loans. Thus, small temporary shocks can cause large

fluctuations in output and prices.

Prior empirical tests of this literature primarily focus on the impact of collateral. For

instance, Gan (2007) considers how a shock to collateral values of Japanese firms significantly

impacts these firms’ abilities to obtain financing and undertake investment. Benmelech and

Bergman (2011) find that a bankruptcy by one airline can significantly reduce the collateral

value of other industry participants, thereby impacting the cost of debt financing for other

airlines. Kahle and Stulz (2012) consider how the recent financial crisis affects firms’

investment and financing. They find that collateral and net worth are important in determining

investment and financing policies. Chaney, Sraer, and Thesmar (2012) find that shocks to real

estate values can have a large impact on U.S. corporate investment. Overall, these empirical

findings are consistent with the collateral channel affecting investment as in Kiyotaki and Moore

(1997).

Related to these studies is Erel et al. (2011), which shows how a firm’s financing over the

business cycle depends on the firm’s credit quality and on macroeconomic conditions. McLean

and Zhao (2012) also consider how the relation between the firm’s investment, Tobin’s q, and

cash flows depends on the business cycle, with firms responding more to Tobin’s q during

expansions and more to cash flows during recessions. While the existing literature emphasizes

the importance of collateral, we instead analyze the impact of creditor legal protection on

mitigating agency problems over the business cycle.

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Our study is related to a substantial literature that discusses the importance of legal

institutions on financial and economic development. Empirical studies in this literature focus on

how cross-country differences in laws and institutions affect corporate behavior, financial

sectors, and aggregate economic growth. This largely follows works by La Porta et al. (1997,

1998), and Demirguc-Kunt and Maksimovic (1998) who show the importance of legal and

institutional factors in explaining the ability of firms to obtain external financing. Djankov,

McLiesh, and Shleifer (2007) examine how creditor rights affect development of private credit

markets, and Demirguc-Kunt and Maksimovic (1999) study the impact of creditor protection on

firms’ debt maturity structures. Qian and Strahan (2007) and Bae and Goyal (2009) show how

greater creditor protection laws imply reductions in the cost of debt capital in private loan

contracts. However, Acharya and Subramanian (2009) show that greater creditor rights imply

lower innovation, and Acharya, Amihud, and Litov (2011) find reduced risk-taking for

companies in greater creditor rights regimes. In contrast to these studies, we examine the

differential impact of creditor protection laws over the business cycle on firm debt financing, the

cost of debt, and investment.

Bernanke and Gertler (1989) suggest that increased agency problems during recessions

lower a firm’s capacity to access external debt financing, leading to a decline in investment

during economic downturns. Thus, the first question we investigate is whether creditor

protection laws impact debt financing differently over the business cycle, and therefore whether

stronger creditor protection moderates the decline in debt financing in recessions. To address

this question, we employ firm-level regressions using data from 40 countries. We regress debt

financing on the interaction between a creditor rights index and a variable that measures

macroeconomic conditions as well as a set of control variables. If agency problems increase

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during recessions and if creditor protection laws mitigate these agency costs, then the coefficient

estimate on the interaction term between creditor protection and macroeconomic conditions

should be positive. That is, a positive coefficient estimate suggests that creditor rights have a

greater impact on debt financing during recessions than expansions, and that creditor rights help

smooth the dynamics of debt financing over the business cycle. Additionally, we extend this

analysis by examining whether the cost of debt has a different relation with creditor protection

laws over the business cycle.

The second question we examine is whether greater creditor protection has a different

effect on investment during recessions than expansions, and thus whether creditor rights help

moderate investment dynamics over the business cycle. We consider a similar regression at the

firm level, regressing the firm’s capital expenditures on the interaction between a creditor rights

index and a variable that measures macroeconomic conditions as well as a set of control

variables. The coefficient estimate on these interaction terms captures the differential effect of

creditor rights on investment over the business cycle. A positive coefficient estimate on the

interaction term would suggest that better creditor protection has a greater association with

investment during economic downturns than upturns. Given that investment is lower during

recessions than expansions, a positive coefficient is consistent with greater creditor rights

moderating the decline in investment during recessions.

In further tests we examine whether the effects of creditor rights in recessions are greater

for firms with more severe bondholder-stockholder agency problems. To highlight the effect of

creditor protection laws in mitigating increased agency conflicts during recessions, we split our

sample into firms with high and low expected agency costs. We re-estimate the firm-level

regressions separately for these subsamples. If creditor rights are important in mitigating agency

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conflicts during recessions, we would expect that the coefficient estimate on the interaction term

between creditor rights and the macroeconomic variable is greater for the high agency-cost

subsamples.

3. Data

In this section, we describe our main variables of interest and the selection of controls.

Table 1 provides detailed definitions of the variables we employ in this study.

3.1. Investment, Debt Financing, and Firm Characteristics

We gather our firm-level variables from international financial statement data using the

Worldscope database and corporate bond data from FISD. The dependent variables for our study

are the amount of debt financing, the cost of debt, and firm investment. We measure debt

financing as the change in total debt from the firm’s balance sheet over the fiscal year divided by

lagged total assets. Alternatively, we measure debt financing as the difference between long-

term debt issuance and repayment divided by lagged total assets. We measure the cost of debt as

the logarithm of the yield spread, that is, the yield-to-maturity on the bond less the yield of

nearest maturity Treasury bond. We limit the yield spread analysis to fixed coupon bonds only.

We measure firm investment as capital expenditures divided by lagged total assets.

Alternatively, we measure firm investment as capital expenditures plus R&D expenses divided

by lagged total assets; as capital expenditures divided by PPE (property, plant, and equipment);

or as the change in total assets divided by lagged total assets.

We use a number of firm-level control variables that the literature has shown to be

important for our analysis. We measure firm size with the logarithm of total assets. We measure

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Tobin’s q as (total assets – book value of equity + market value of equity) / total assets. We

calculate cash flow as net income plus amortization and depreciation divided by total assets,

leverage as the ratio of total debt to total assets, and tangibility as the ratio of PPE to total assets.

Total assets, Tobin’s q, leverage, and tangibility are lagged one year to mitigate endogeneity

concerns. Our key independent variables, the creditor rights index and our measures of

recessions, are effectively exogenous as neither is significantly affected by individual firm-level

investment or borrowing. We winsorize all variables at the 1% and 99% level to avoid having

outliers drive the results. Further, we control for industry fixed effects using the 30 Fama/French

industry classifications obtained from Ken French’s website.

3.2. Measures of International Business Cycles

To examine how business cycles and creditor protection laws impact firm investment

policy and financing behavior, we construct business cycle measures for all the countries we

consider. Our primary data source to create these measures is the International Financial

Statistics (IFS) database from the International Monetary Fund (IMF). We use quarterly GDP

data and quarterly GDP deflators to calculate quarterly real GDP growth rates for each country in

our sample.7 We use the seasonally adjusted data series for Australia, Canada, France, Germany,

Italy, Japan, Mexico, Netherlands, New Zealand, South Africa, Spain, Switzerland, United

Kingdom, and United States. For other countries, IFS does not provide seasonal adjusted

quarterly GDP data and we use the X-12-ARIMA approach from the U.S. Census Bureau to

adjust the GDP data for seasonality (see Brockman, Liebenberg, and Schutte, 2010).8 We merge

real quarterly GDP growth rates with firm-level data based on a firm’s fiscal year end date. We

7 Monthly GDP data is available for a few countries over recent years only. 8 In practice, using unadjusted GDP growth rates to construct the recession variables does not impact our findings.

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define a firm as being subject to a recession if any two consecutive quarterly real GDP growth

rates in the country where the firm is domiciled were negative during the firm’s fiscal year.

Alternatively, instead of using an indicator variable to identify business cycles, we use the annual

real GDP growth rate to measure macroeconomic conditions in our tests (see, e.g., Erel et al.,

2012).

3.3. Measures of Legal Institutions

We use an index of aggregate creditor rights to measure a country’s creditor protection

laws. The creditor rights index is time varying and compiled for each year from 1978 to 2003.

The data are obtained from Djankov, McLiesh, and Shleifer (2007). Starting from a score of

zero, the creditor rights index is incremented by one as each of the following requirements is

met: (1) there are restrictions, such as creditor consent or minimum dividends, for a debtor to file

for reorganization; (2) secured creditors are able to seize their collateral after the reorganization

petition is approved, i.e., there is no automatic stay or asset freeze; (3) secured creditors are paid

from the proceeds of liquidating a bankrupt firm before other creditors such as the government or

workers; and (4) management does not retain administration of its property pending the

resolution of the reorganization. The creditor rights index ranges from zero to four with higher

scores corresponding to stronger creditor protection.

An advantage of the creditor rights index is that it is compiled for each year and thus

allows us to have a time-varying measure of creditor protection laws over our sample period.

However, this creditor rights index is only available up to 2003. Currently, there exists no

alternative index that captures creditor rights laws for a large number of countries over an

extended time period. One approach is to extrapolate the index for future years using the index

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values of 2003. However, as Kadiyala and John (2012) show, a number of countries changed

their bankruptcy and creditor protection laws in recent years. Hence, extrapolating the creditor

rights index for years after 2003 will not capture these reforms, and this can lead to biases in the

analysis post 2003. We therefore choose to report our primary results for the 1980 (start of firm-

level data coverage) to 2003 (end of creditor rights data) time period. As a robustness check, we

extrapolate the creditor rights scores up to 2008.

We follow Qian and Strahan (2007) and control for the overall legal environment and

investor protection laws by including legal origin dummy variables in our regression. We also

control for other determinants of a country’s legal institutions to protect creditors in addition to

the creditor rights index. Specifically, following Qian and Strahan (2007), we control for legal

formalism and legal rights. The legal formalism index is obtained from Djankov et al. (2003)

and measures substantive and procedural statutory intervention in judicial cases at lower-level

civil trial courts. The index ranges from zero to seven where seven means a higher level of

control or intervention in the judicial process. The legal rights index, obtained from World Bank

Group’s Doing Business Website (see Djankov, McLiesh, and Shleifer, 2007), measures the

degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and

thus facilitate lending. This index ranges from zero to ten, with higher scores indicating that

collateral and bankruptcy laws are better designed to allow access to credit. In contrast to the

creditor rights index, none of these other indexes is time-varying.

In order to control for the country’s initial economic development, we include the

logarithm of the per capita GDP in 1980 measured in U.S. dollars. We use the initial GDP per

capita in 1980 rather than annual GDP per capita to avoid collinearity between the annual GDP

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growth rate and our recession dummy variable. The GDP data is obtained from the IMF

International Financial Statistics database.

We exclude financial firms (first SIC-digit of 6) and public administration firms (first

SIC-digit of 9) from our sample as measures of investment and debt financing are not easily

comparable for these types of firms. Further, we exclude firms with total assets less than $10

million or firms that do not have publicly traded equity. We also require that countries have data

for at least three consecutive years in order to better construct business cycle indicators. Our

final sample consists of 134,862 firm-year observations covering 18,979 firms across 40

countries.

4. Empirical Results

4.1. Summary Statistics

Table 2 provides summary statistics by country. The countries with the most firm-year

observations falling in a recession, as measured with our recession dummy, are Argentina (67%),

Peru (54%), and Brazil (46%), and the countries with the lowest fraction of firm-year

observations during recessions are China, Hungary, Ireland, and Morocco (0%). These latter

countries have relatively few firm-year observations, and our results are not driven by these

observations. As for the creditor rights variable, this index is widely distributed with a range in

value from zero to four, with countries like Colombia, France, Mexico, and Peru having a score

of zero and Hong Kong and New Zealand having a score of four. Overall, the U.S. has the most

observations, followed by Japan and the U.K.

Table 3 provides summary statistics on our sample. Our recession dummy indicates that

recessions occur in 16% of firm-year observations, and the average annual real GDP growth rate

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is 3%. Firm-level capital expenditure is on average 7.2% of total assets. Firms increase debt

financing by an average of 2.5% of total assets per year. Splitting the sample into periods of

recessions and expansions, on average, capital expenditures are 7.3% and 6.4% of total assets in

expansions and recessions, respectively. Similarly, debt financing is, on average, 2.7% of total

assets in economic upturns and drops to 1.1% during downturns (untabulated). These two

differences are statistically significant at the 1% level. Panel B of Table 3 reports correlations

between some of the variables of interest. As expected, new debt financing and capital

expenditures are negatively correlated with recessions. Creditor rights are positively associated

with debt financing as well as with capital expenditures, although these correlation coefficients

are close to zero.

4.2. Debt Financing, Business Cycles, and Creditor Rights

We begin by examining the primary channel through which creditor rights impacts

investment; that is, through better access to debt markets during economic downturns. Thus, we

analyze how creditor rights are related to a firm’s debt financing behavior around recessions with

regressions which use debt financing as the dependent variable. Debt financing is calculated as

the change in total debt as a fraction of total assets. All regressions include firm size, Tobin’s q,

cash flow, leverage, and tangibility as control variables. Following McLean and Zhao (2012)

and Kaplan and Zingales (1997), all right-hand side variables are lagged one year, with the

exception of cash flow, which is from the concurrent year. The regressions also include industry

and time dummies, and we control for the general legal environment and development of a

country using legal origin dummies and the logarithm of the initial GDP per capita. To allow for

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differences in coefficients over the business cycle, we interact the independent variables with the

recession variable.9

The regression in, column 1 of Table 4 includes creditor rights and an interaction term

with the recession dummy. Consistent with our hypotheses, creditor rights have a greater impact

on firms’ debt financing during recessions compared to expansions—the coefficient on the

interaction term between creditor rights and recession is positive and significant at the 1% level.

Figure 1 graphically illustrates these results by showing that stronger creditor rights are

associated with significantly greater debt financing during recessions. In contrast, creditor rights

have no significant impact on debt financing during expansions. For the recessions subsample, a

change from weak creditor rights (score of zero) to strong creditor rights (score of four) is

associated with a 2 percentage point increase in debt financing.10

In column 2 of Table 4, we add the legal rights index as an additional measure of creditor

protection, and in column 3 we include a measure of legal formalism. Neither of these variables

nor their interactions with the recession dummy is significantly related to debt financing, and the

coefficient estimate on the interaction between creditor rights and the recession dummy is only

marginally impacted by the addition of these variables. Column 4 of Table 4 provides a

regression with country fixed effects. Across all specifications, the coefficient on the interaction

between creditor rights and the recession dummy is positive and significant, and this suggests

that the effect of creditor protection laws on debt financing is mainly concentrated during

economic downturns.

9 Note that the recession variable is dropped from this specification because it is collinear with the totality of the interaction terms. 10 Similar to the investment regressions, when we estimate the debt financing regressions separately for recessions and expansions we find that creditor rights is positively and significantly associated with debt financing during recessions (coefficient of 0.558 with p-value of less than 5%) but not during expansions (coefficient of -0.188 with p-value greater than 10%).

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We further consider whether the sum of the coefficients on the creditor rights index and

on the interaction between creditor rights and recession is significantly different from zero, and

we report the p-values for this test in the last row of Table 4. In all models, the sum of these

variables is significantly different from zero (with p-values less than 5%). Thus, stronger

creditor rights have a greater impact on debt financing during recessions than in expansions, and

similar to our findings on firm investment, the decline in debt financing during recessions is

moderated by greater creditor rights.

In terms of economic magnitude, based on the results of column 1 of Table 4, an increase

of one unit in creditor rights implies an insignificant change in debt financing during expansions,

and a significant increase during recessions of 0.548 percentage points (= 0.718-0.170). Given

average debt financing of 1.06% during recessions, this implies a 52% (= 0.548/1.06) increase in

debt financing with an increase of one in creditor rights.

Table 5 repeats the regressions of Table 4 using the real GDP growth rate rather than a

recession dummy to proxy for macroeconomic conditions. In all specifications, the coefficient

on the interaction between creditor rights and the real GDP growth rate is negative and

significant, again implying that creditor rights are associated with increased borrowing if GDP

growth is low.

The coefficients on the other control variables in Tables 4 and 5 are largely consistent

with our expectations. We find that firms with greater tangibility, measured with PPE to total

assets, and highly valued firms, measured with Tobin’s q, have greater debt financing, and highly

levered firms have lower debt financing. For the most part, the interaction terms between the

control variables and the recession variables are not significantly different from zero.

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4.3. Cost of Debt, Business Cycles, and Creditor Rights

Qian and Strahan (2007) and Bae and Goyal (2009) show that bank loans have lower

spreads and longer maturities for companies in high creditor rights regimes, and Qi, Roth, and

Wald (2010) show that Eurobonds and Yankee bonds have lower spreads if they are from high

creditor rights regimes. We therefore examine whether our results on firm investment and debt

financing extend to the relation between the cost of debt and creditor rights. We expect that

strong creditor rights reduce spreads, and that this effect is more pronounced in recessions than

in expansions.

We consider a sample of corporate Yankee bonds (bonds issued by non-U.S. issuers)

issued between 1980 and 2003 from the Fixed Income Securities database (FISD).11 Dropping

bonds issued by governments, bonds with missing offering yields, convertible bonds, and bonds

with floating rate coupons results in a sample of 1,726 Yankee bonds issued by 757 firms from

37 countries. The countries with the largest number of observations are Canada (28%) and

United Kingdom (22%). After merging the bond sample with firm-level data we obtain a smaller

sample of 291 bonds from 19 countries.

We use the log of bond yield spread at the time of the bond issue to measures the cost of

debt (see, e.g., Elton, Gruber, Agrawal, and Mann, 2001; Maxwell and Stephens, 2003; and Qi,

Roth, and Wald, 2010). We calculate the yield spread as the difference between the offering

yield and the yield on the maturity equivalent U.S. Treasury bond. If there is no maturity

equivalent Treasury security available to match the maturity of the corporate bond, the yield to

maturity on the Treasury security is calculated as a linear interpolation between the two closest

maturity matches.

11 We exclude domestic U.S. bonds because adding these issues would make the sample 94% U.S. based, thus swamping our results for non-U.S. issuers.

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In addition to the control variables we employ in our previous tests, we consider term

spread, measured as the difference between the yields on one and ten year Treasury bonds; and

default spread, calculated as the difference between the yields on Baa and Aaa rated corporate

bonds. Further, we control for various bond characteristics including the log of maturity, log of

offering amount, and indicator variables for whether the bond is callable, putable, or secured, and

whether it is a high-yield issue. These bond characteristics may be jointly determined with the

bond’s offering yield, and we therefore estimate our models with and without these bond

controls.

Table 6 provides regressions of how spreads vary with recessions, creditor rights, and

their interactions. We use the recession dummy to measure macroeconomic conditions.12 The

model in column 1 controls for log of initial GDP per capita, and term and default spread,

column 2 adds firm fixed effects, column 3 includes firm controls, column 4 includes firm and

bond controls, and column 5 is estimated with country fixed effects. Note that the sample size

drops from 1,726 observations in models 1 and 2 to 291 observations in columns 3 to 5 when

firm and bond characteristics are included. In all specifications, the coefficient on the interaction

between creditor rights and the recession dummy is negative and significant with p-values of less

than 5% (in four out of five models). Thus, creditor rights have a significantly greater effect on

the cost of debt during recessions than expansions.

Overall, the evidence we find on the relation between creditor rights, recessions, and the

cost of debt is consistent with our prior tests. Greater creditor rights moderate fluctuations in

yield spreads over the business cycle.

12 The results hold when we use real GDP growth the proxy for macroeconomic conditions. For brevity, we do not report these results in separate tables.

20

4.4. Investment, Business Cycles, and Creditor Rights: Firm-level Analysis

We next turn to our firm-level analysis of the impact of creditor protection laws on

corporate investment policy over the business cycle. Table 7 presents our estimates from

regressing investment as a fraction of total assets on creditor rights, a recession dummy, and

other controls. Column 1 of Table 7 presents the results of our basic specification, similar to

column 1 of Table 4. The coefficient on the interaction term between recession and creditor

rights provides the differential impact of creditor rights in recessions compared to expansions.

Consistent with our expectations, the interaction between recession and creditor rights is

significantly positively associated with firm investment (p-value less than 1%). This finding

suggests that creditor rights have a significantly greater impact on firm investment in economic

downturns than in upturns. Figure 2 graphically illustrates the effect of creditor rights during

expansions and recessions based on this analysis. The graph shows that weak creditor rights are

associated with significantly lower capital investment during recessions — for example, for the

recession subsample, an increase from weak creditor rights (score of zero) to strong creditor

rights (score of four) implies an increase in investments of about 38%. In contrast, during

expansions, differences in creditor rights imply little variation in investment.13

In column 2 of Table 7 we add the legal rights index as an additional control for creditor

protection (see Djankov, McLiesh, and Shleifer, 2007). Consistent with creditor protection

mattering more during recessions, the coefficient on the interaction between the legal rights

index and the recession dummy is positive and significant. In column 3 of Table 7 we consider

the legal formalism index from Djankov, La Porta, Lopez-de-Silanes, and Shleifer (2003);

13 When we estimate the investment regressions separately for recessions and expansions, our results are consistent with the findings in Table 7. Creditor rights are positively and significantly associated with investment during recessions (coefficient of 0.503 with p-value less than 1%) but not during expansions (coefficient of -0.039 with p-value greater than 10%).

21

however, neither this index nor its interaction with the recession dummy is significant in this

specification. Overall, the inclusion of these additional institutional variables has only a small

effect on the interaction between creditor rights and the recession dummy. In column 4 of Table

7, we provide a regression with country fixed effects.14 Overall, across all these specifications,

the coefficient on the interaction between creditor rights and the recession dummy is positive and

significant, again suggesting that better creditor rights have a greater impact on corporate

investment during recessions than expansions.

In the last row of Table 7, we report p-values for the test that the sum of the coefficients

on creditor rights and the interaction between creditor rights and the recession dummy is

different from zero. For all models, this sum is significantly different from zero (with p-values

less than 1%), whereas the coefficient on creditor rights by itself is not different from zero except

in the country fixed effect specification, where the creditor rights variable picks up the

investment effects of within country changes in creditor rights. Thus, our findings suggest that

greater creditor rights are associated with greater investment during recessions when agency

conflicts are potentially high, and creditor rights have little impact on investment during

expansions.

In terms of economic magnitude, the findings in column 1 of Table 7 show that an

increase of one unit in the creditor rights index implies a 0.489 (= 0.547-0.058) percentage point

increase in capital expenditure during recessions, and no significant change during expansions.

Given that the average capital expenditure is 6.43% of total assets during recessions, a one unit

increase in creditor rights implies an increase in capital expenditure of 7.6% (= 0.489/6.43)

during recessions and no significant change during expansions.

14 In our sample, out of the 40 countries, there are 8 countries for which the creditor rights variable changed over time, Canada, Denmark, Finland, Israel, Japan, Sweden, Thailand, and the U.K.

22

In Table 8 we consider the annual real GDP growth rate as an alternative measure of

economic activity for similar specifications to those provided in Table 7. The estimated

coefficient on the interaction between the real GDP growth rate and creditor rights is in all cases

negative, and again this finding implies that creditor rights have a positive effect on firm

investment if GDP growth is lower. The estimated coefficient on this interaction term is

significant in three out of the four models.

In both Tables 7 and 8 the estimated coefficients on the other control variables are, on the

whole, consistent with our expectations. Firms with greater cash flow and firms with more

growth opportunities, as measured by Tobin’s q, generally invest more. Further, large firms and

firms with greater leverage invest more during recessions. While firms with more tangible assets

invest more, they also see a greater decline in investment during recessions. This is consistent

with prior empirical studies on the collateral channel (see, e.g., Gan, 2007; Benmelech and

Bergman, 2011; and Chaney, Sraer, and Thesmar, 2012).

4.5. Agency Cost Subsamples

Our results show that the impact of creditor protection on corporate investment policy,

debt financing, and the cost of debt is concentrated during recessions. If these different effects of

creditor rights are due to increased agency costs during recessions, we expect that the impact of

creditor rights in recessions should be more pronounced for firms which have greater expected

agency problems. To this end, we split our data into subsamples containing firms which we

expect to have more or fewer agency problems, and we repeat our previous analysis using these

subsamples.15 Myers (1977), for instance, discusses how firms with greater outstanding long-

15 Because of the small sample size of the cost of debt sample, we are unable to perform meaningful splits within that sample.

23

term debt have a greater bondholder-shareholder conflict, and are more likely to not undertake

profitable investment opportunities. Jensen and Meckling (1976) show how shareholders of

firms with more debt have greater incentives to change to riskier projects, even if this implies a

decrease in overall firm value. These agency conflicts are more pronounced if the firm is closer

to bankruptcy, as limited liability causes the incentives for shareholders and bondholders to

diverge. Thus, we proxy for bondholder-shareholder agency problems with leverage and

revenue, and we expect that firms with high leverage or low revenue are more affected by

agency problems.

Another variable which may be related to bondholder-shareholder conflicts is bond

ratings. We gather rating data but find that these data are not available for most of the firms in

our sample. A number of other variables, such as corporate governance or ownership measures,

are also used in the literature to proxy for agency problems; however, these are related to

measures of owner-manager agency problems, not shareholder-bondholder conflicts, and hence,

these measures are not useful for our analysis.

Table 9 presents the results for debt financing for subsamples based on variables which

are related to bondholder-stockholder agency costs. The first two columns of Table 9 consider

firms with leverage that is higher or lower than the median industry leverage. Columns 3 and 4

split the sample into firms with leverage greater than or less than 40%, and columns 5 and 6

consider firms with leverage greater than or less than 50%. Finally, columns 7 and 8 consider

firms with revenue less than or greater than the industry median.16 The results suggest that

creditor rights have a positive impact on debt financing during recessions for both the high and

low potential agency conflict subsamples. However, the estimated coefficients on the interaction

16 In unreported analyses we also split the samples by country median and industry-country median, and find similar results.

24

terms are greater for the high-agency-cost subsamples, and this difference is significant for three

out of four subsample splits. For example, focusing on the high/low leverage subsamples in

columns 1 and 2, the coefficients on the interaction term are 1.166 for firms with high leverage

and 0.399 for firms with low leverage, and the difference is significant at the 5% level.

In Table 10 we consider investment regressions for similar subsamples. In all models the

coefficient on the interaction between creditor rights and recession is positive and significant

with p-values less than 1%, and the coefficients are larger for the subsamples which we expect to

have greater agency problems. However, the differences in estimated coefficients from these

subsamples are statistically significant at the 10% level in columns 5 and 6, which report results

for the 50% leverage cutoff subsamples. In columns 7 and 8, which show results for the revenue

subsamples, the difference in coefficients is not significant with a p-value of 13%.

In sum, these measures of expected agency problems are related to how creditor rights

affect firm investment and debt financing during recessions, and the results are consistent with

the notion that strong creditor rights are most important during recessions for firms with high

agency costs.

4.7. Alternative Analyses and Robustness Tests

We consider a number of additional tests to ensure the robustness of our findings.

4.7.1. Country-level Analysis

In unreported regressions, we consider the effect of creditor rights on country-level

investment in a simple regression using country-level fixed effects. We define investment as the

ratio of gross fixed capital formation to GDP using IFS data. We find that the interaction

25

between recessions and creditor rights is consistently positive in this analysis, and the results

hold either with a recession dummy or with lagged GDP growth. This analysis provides another

view that our firm-level analysis is reflected in macroeconomic data. However, because of the

number of additional macroeconomic controls that could be included in such a macroeconomic

analysis, we focus instead on our firm-level analyses.

4.7.2. Equity Issuance and Cash Holdings

In unreported regressions we consider equity financing and cash holdings as dependent

variables in our analyses. Neither creditor protection laws nor other institutional features affect

the relation between recession and equity financing or cash holdings. Thus, creditor protection

laws mitigate the drop in investment during recessions through changes in debt financing, not

through changes in equity financing or through changes in cash holdings.

4.7.3. Graphical Analysis of Agency Costs over the Business Cycle

We also consider a graphical analysis of how agency problems between borrowers and

lenders increase around recessions using data from U.S. bond issues.17 Smith and Warner (1979)

describe how covenants are included in debt contracts to reduce the incidence of various types of

agency conflicts, and we therefore use the number of covenants included in bond contracts as a

measure of expected agency conflicts.18 We examine the number of covenants included in U.S.

corporate bonds by firm rating during recessions and expansions. We obtain data on the use of

covenants in U.S. corporate bonds from the Mergent’s Fixed Income Securities Database (FISD)

database. Our sample contains 46,141 bonds issued from 1990 to 2008.

17 We constrain this analysis to the U.S. as covenant data for international bonds is limited. 18 An existing literature documents how covenant use is tied to agency issues; see, for instance, Malitz, 1986; Begley and Feltham, 1999; Nash, Netter, and Poulsen, 2003; Billett, King, and Mauer, 2007; and Qi, Roth, and Wald, 2011.

26

Figure 3 shows Moody’s bond ratings on the horizontal axis (from 2 (C rating) to 22 (Aaa

rating)) and the average number of covenants included in bonds on the vertical axis. As

expected, lower rated bonds include more debt covenants than higher rated bonds. Moreover,

during recessions, the number of covenants used by high rated bonds increases significantly.

There are no observations for the number of covenants issued by firms with ratings 2 through 4

in recessions, suggesting that firms with low ratings are unable to issue bonds during recessions.

This graphical analysis shows that agency problems increase during recessions, and it suggests

that these agency problems can be severe enough to shut low rated firms out of credit markets

during recessions.

4.7.4. Alternative Variables

In unreported regressions we consider the anti-self-dealing index from Djankov, La

Porta, Lopez-de-Silanes, and Shleifer (2008) as another control variable in our regressions.

Including this variable does not change our primary results, and the coefficients on anti-self-

dealing are largely insignificant. As we are primarily concerned with the agency costs between

creditors and shareholders, rather than between shareholders and management, this result is

expected. Further, as we control for legal origin variables, this additional variable may not

provide much additional information. We also consider an anti-director index, rather than the

anti-self-dealing index, and again we find similar results.

We consider several alternative variable definitions as additional robustness tests. For

instance, we use an alternative measure of recession, equal to one if the annual real GDP growth

rate is negative, rather than if it is negative for two consecutive quarters of the year. Our results

hold for both investment and debt financing. Further, our results are robust to using seasonally-

27

unadjusted GDP to calculate the recession measures. Our results also hold when we measure

investment as capital expenditures plus R&D expenses divided by lagged total assets; as capital

expenditures divided by PPE (property, plant, and equipment); or as the change in total assets

divided by lagged total assets. They also hold when we measure debt financing as net debt

issuances scaled by lagged total assets.

4.7.5. Subsamples

To ensure that our results are not driven by any particular country, we consider various

subsamples (untabulated). Specifically, we exclude the three countries with the most

observations, U.S., Japan, and the U.K.—we exclude them jointly from the analysis and one at a

time and find similar results. We exclude each individual country, and again find little impact on

our results—thus, our findings are not driven by any one country’s particular experience. We

also exclude years before 1990 to have a more balanced panel and to address concerns of limited

firm coverage in years prior to 1990; this has little impact on our results.

4.7.6. Extended Sample Period

In unreported regressions we extend the sample period by including data up to 2008,

using the 2003 creditor rights index. Since a number of countries went through credit reforms

after the year 2003, extending the 2003 creditor rights index for later years is likely to induce

noise into our estimation, potentially resulting in weaker results.

Overall, our prior results are confirmed when extending the sample. For the investment

regressions using the recession dummy, we estimate a significant positive coefficient on the

interaction between creditor rights and the recession dummy. Using the annual real GDP growth

28

rate, the coefficient on the interaction term is negative and significant with a p-value less than

10%. However, consistent with additional noise, the estimated coefficients have smaller

magnitude than for the shorter sample. The results for the debt financing analysis in this

extended sample are also similar to our primary analysis.

4.7.7. Creditor Rights Index Component Analysis

In untabulated tests we consider which components of the creditor rights index have the

greatest effect on both firm investment and debt financing. This analysis potentially shows

which elements of credit reform are most important, and also allows us to examine whether the

same component matters for investment and debt financing. We breakdown the creditor rights

index in its four components, which are, a) restrictions on reorganization, b) no automatic stay,

c) secured creditors are paid first, and d) management does not stay. We find that while several

components are significant when considered individually, when added together, only the variable

that proxies for whether management stays in bankruptcy, is significant for both the investment

and debt financing regressions. Thus, the power of management appears to be the most

important element, and that holds for both investment and financing outcomes around recessions.

5. Conclusion

Firm-level investment often drops precipitously during recessions, and this can

exacerbate and prolong economic downturns. Motivated by the literature on how increased

agency problems during recessions can alter business cycles (e.g., Bernanke and Gertler, 1989),

we consider how differences in creditor rights affect access to debt finance and investment across

the business cycle. Using a panel of firms from 40 countries, we find that greater creditor rights

29

imply that firms use more debt financing and are able to obtain it at a lower cost during

recessions. Greater creditor rights are also associated with greater firm investment during

recessions. In contrast, greater creditor rights have a significantly smaller effect on firm

investment or debt financing during expansions. These results are both statistically and

economically significant, and they appear to be concentrated in the firms which, a priori, we

expect would have greater bondholder-shareholder agency conflicts.

Our results are robust to alternative definitions of recession, alternative measures of

creditor rights, and country-level fixed effects specifications. The results are consistent with

shareholder-debtholder agency costs increasing during recessions, and with stronger creditor

rights decreasing the negative effects of these agency problems. Thus stronger creditor rights

improve the function of debt markets during economic downturns, and this in turn increases the

availability and lowers the cost of debt capital thereby allowing for more firm-level investment

during recessions.

30

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Table 1 Variable Definitions

Variables Definition

1. Recession Variables

Recession Dummy A dummy variable that equals one if there was a recession during a firm’s fiscal year, and zero otherwise. We define a firm as being in a recession if any two consecutive quarterly real GDP growth rates were negative during the firm’s fiscal year. We use quarterly GDP data and the quarterly GDP deflator to calculate quarterly real GDP growth rates for each country in our sample. We use the seasonally adjusted data series for Australia, Canada, France, Germany, Italy, Japan, Mexico, Netherlands, New Zealand, South Africa, Spain, Switzerland, United Kingdom, and United States. For other countries, IFS does only provide unadjusted quarterly GDP data and we use the X-12-ARIMA approach from the U.S. Census Bureau to adjust the GDP data for seasonality (see also Brockman, Liebenberg, and Schutte, 2010). We merge quarterly GDP growth rates with firm-level data based on a firm’s fiscal year end date. Source: International Financial Statistics (IFS) database from the International Monetary Fund (IMF).

Real GDP Growth The annual real GDP growth rate. Source: International Financial Statistics (IFS) database from the International Monetary Fund (IMF).

2. Firm-level Variables

Capital Expenditure Capital expenditure during the fiscal year divided by total asset of the previous fiscal year (in percentage). Source: Worldscope.

Debt Financing Calculated as the difference between total debt at the end the fiscal year and total debt at the end of the previous fiscal year divided by total asset of the previous fiscal year (in percentage). Source: Worldscope.

Total Assets Total assets in millions of USD. Source: Worldscope. Tobin’s q Calculated as the market capitalization of equity plus total debt divided by total

assets. Source: Worldscope. Cash Flow The sum of net income and depreciation and amortization expense scaled by lagged

total assets. Source: Worldscope. Leverage Leverage is defined as the sum of long- and short-term debt divided by lagged total

assets. Source: Worldscope. Tangibility Property, Plant and equipment (net of accumulated depreciation) scaled by lagged

total assets. Source: Worldscope.

3. Country-level Variables

Real Gross Fixed Capital Formation

Gross fixed capital formation is measured by the total value of a producer’s acquisitions, less disposals, of fixed assets during the accounting period, plus certain additions to the value of non-produced assets (such as subsoil assets or major improvements in the quantity, quality, or productivity of land). Gross fixed capital formation is converted to real values using the GDP deflator. Source: International Financial Statistics (IFS) database from the International Monetary Fund (IMF).

Real GDP GDP converted to real values using the GDP deflator. Source: International Financial Statistics (IFS) database from the International Monetary Fund (IMF).

Creditor Rights An index aggregating creditor rights. A score of one is assigned when each of the following rights of secured lenders are defined in laws and regulations: (1) there are restrictions, such as creditor consent or minimum dividends, for a debtor to file for

34

reorganization; (2) secured creditors are able to seize their collateral after the reorganization petition is approved, i.e., there is no automatic stay or asset freeze; (3) secured creditors are paid first out of the proceeds of liquidating a bankrupt firm, as opposed to other creditors such as government or workers; and (4) management does not retain administration of its property pending the resolution of the reorganization. The index ranges from 0 (weak creditor rights) to 4 (strong creditor rights) and is constructed for every year from 1978 to 2003. The index is time-varying. Sources: Bankruptcy and reorganization laws, Djankov, McLiesh, and Shleifer (2007), and La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998).

Legal Rights Measures the degree to which collateral and bankruptcy laws protect the rights of borrowers and lenders and thus facilitate lending. The index ranges from 0 to 10, with higher scores indicating that collateral and bankruptcy laws are better designed to expand access to credit. Sources: World Bank Group’s Doing Business Website and Djankov, McLiesh, and Shleifer (2007).

Legal Formalism The index measures substantive and procedural statutory intervention in judicial cases at lower-level civil trial courts, and is formed by adding up the following indices: (i) professionals versus laymen, (ii) written versus oral elements, (iii) legal justification, (iv) statutory regulation of evidence, (v) control of superior review, (vi) engagement formalities, and (vii) independent procedural actions. The index ranges from 0 to 7 where 7 means a higher level of control or intervention in the judicial process. Source: Djankov, La Porta, Lopez-de-Silanes, and Shleifer (2003).

Legal Origin Dummies Identifies the legal origin of the company law or commercial code of each country (English, French, Socialist, German, and Scandinavian). Source: Djankov, McLiesh, and Shleifer (2007).

Initial GDP/Capita GDP per capita in 1980 in USD. Source: International Financial Statistics (IFS) database from the International Monetary Fund (IMF).

Term Spread Measures the difference between the yields on one and ten year Treasury bonds. Source: Federal Reserve Bank of St. Louis.

Default Spread Calculated as the difference between the yields on Baa and Aaa rated corporate bonds. Source: Federal Reserve Bank of St. Louis.

4. Yankee Bond Sample Variables

Cost of debt The cost of debt is measured with the bond yield spread on the bond calculated as bond yield spread at the time of the bond issue to measures the cost of debt (see, e.g., Elton, Gruber, Agrawal, and Mann, 2001; Maxwell and Stephens, 2003; and Qi, Roth, and Wald, 2010). We calculate the yield spread as the difference between the offering yield and the yield to maturity on its maturity equivalent risk-free bond. We use the constant maturity Treasury security series obtained from the Federal Reserve Board as risk-free bonds. If there is no maturity equivalent Treasury security available to match the maturity of the corporate bond, the yield to maturity on the Treasury security is calculated as the linear interpolation between the two closest maturity matches. Source: Fixed Income Securities database (FISD)

Maturity Is the bond’s maturity in years. Source: FISD. Offering Amount Is the offering amount in millions of USD. Source: FISD. Convertible Bond Dummy variable that equals one if the bond is a convertible bond, and zero otherwise.

Source: FISD. Callable Bond Dummy variable that equals one if the bond is callable, and zero otherwise. Source:

FISD. Putable Bond Dummy variable that equals one if the bond is a putable, and zero otherwise. Source:

FISD.

35

High Yield Bond Dummy variable that equals one if the bond is a high yield bond (below investment grade), and zero otherwise. Source: FISD.

36

Table 2 Descriptive Statistics by Country

This table shows averages by country. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. Country Recession

Dummy Creditor Rights

Legal Origin # Obs # Firms Start End

Argentina 0.67 1.00 2.00 281 57 1993 2003 Australia 0.08 3.00 1.00 2,851 508 1980 2003 Austria 0.19 3.00 3.00 750 90 1980 2003 Belgium 0.16 2.00 2.00 993 107 1980 2003 Brazil 0.46 1.00 2.00 861 205 1994 2003 Canada 0.10 1.29 1.00 5,458 823 1980 2003 Chile 0.10 2.00 2.00 608 122 1995 2003 China 0.00 2.00 3.00 1,565 1,104 1999 2003 Colombia 0.19 0.00 2.00 113 22 1993 2003 Denmark 0.33 2.98 4.00 1,192 127 1980 2003 Finland 0.17 1.52 4.00 1,069 128 1980 2003 France 0.06 0.00 2.00 5,739 719 1980 2003 Germany 0.24 3.00 3.00 5,301 679 1980 2003 Hong Kong 0.44 4.00 1.00 2,825 563 1980 2003 Hungary 0.00 1.00 3.00 105 21 1994 2003 Indonesia 0.13 2.00 2.00 788 186 1996 2003 Ireland 0.00 1.00 1.00 157 43 1997 2003 Israel 0.14 3.03 1.00 344 94 1992 2003 Italy 0.23 2.00 2.00 1,832 233 1980 2003 Japan 0.29 2.16 3.00 25,612 3,028 1980 2003 Jordan 0.15 1.00 2.00 13 6 1997 2003 Malaysia 0.22 3.00 1.00 2,747 569 1991 2003 Mexico 0.08 0.00 2.00 837 113 1981 2003 Morocco 0.00 1.00 2.00 32 12 1997 2003 Netherlands 0.02 3.00 2.00 1,738 189 1980 2003 New Zealand 0.13 4.00 1.00 461 77 1987 2003 Norway 0.09 2.00 4.00 1,090 159 1980 2003 Peru 0.54 0.00 2.00 273 63 1991 2003 Philippines 0.10 1.00 2.00 647 115 1988 2003 Poland 0.16 1.00 3.00 269 60 1994 2003 Portugal 0.27 1.00 2.00 438 59 1985 2003 South Africa 0.21 3.00 1.00 1,990 296 1980 2003 South Korea 0.07 3.00 3.00 3,373 712 1980 2003 Spain 0.06 2.00 2.00 1,455 156 1980 2003 Sweden 0.29 1.40 4.00 1,806 264 1980 2003 Switzerland 0.38 1.00 3.00 1,968 212 1980 2003 Thailand 0.21 2.39 1.00 1,725 306 1993 2003 Turkey 0.36 2.00 2.00 647 130 1988 2003 United Kingdom 0.12 3.96 1.00 12,134 1,441 1980 2003 United States 0.08 1.00 1.00 42,775 5,181 1980 2003

37

Table 3 Summary Statistics

This table shows summary statistics for selected variables. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. Panel A presents descriptive statistics for the country and firm-level sample. Panel B provides correlations for a subset of our variables for the firm-level sample. Panel A: Descriptive Statistics Variable Mean SD Min Max # Obs Recession Dummy 0.16 0.37 0.00 1.00 134,862 Annual Real GDP Growth 0.03 0.03 -0.17 0.22 134,862 Creditor Rights 1.91 1.18 0.00 4.00 134,862 Legal Rights Index 7.07 1.74 3.00 10.00 134,862 Formalism Index 2.82 0.65 0.73 5.60 134,862 Anti-self-dealing Index 0.60 0.20 0.16 0.96 134,862 Log (Initial GDP/Capita) 9.74 0.87 5.42 10.60 134,862 Capital Expenditure (%) 7.18 8.10 0.00 58.14 125,658 Debt Financing (%) 2.46 13.59 -32.04 78.91 121,007 Log (Total Assets) 5.69 1.73 2.30 13.26 134,862 Tobin’s q 1.58 1.56 0.45 30.94 134,862 Cash Flow 0.07 0.12 -0.58 0.46 134,862 Leverage 0.25 0.21 0.00 1.96 134,862 Tangibility 0.38 0.27 0.01 1.38 134,862

38

Panel B: Correlations

Recession Dummy

Capital Expenditure

Debt Financing

Log (Total Assets)

Tobin’s q Cash Flow Leverage Tangibility Creditor Rights

Recession Dummy 1.00 Capital Expenditure -0.04 1.00 Debt Financing -0.05 0.33 1.00 Log (Total Assets) 0.03 -0.01 -0.04 1.00 Tobin’s q -0.09 0.13 0.08 -0.07 1.00 Cash Flow -0.04 0.28 0.05 0.08 0.08 1.00 Leverage 0.04 -0.04 -0.12 0.16 -0.12 -0.14 1.00 Tangibility -0.01 0.40 0.07 0.16 -0.08 0.16 0.20 1.00 Creditor Rights 0.11 0.01 0.00 -0.03 -0.04 0.02 -0.05 0.03 1.00 Log (Initial GDP/Capita) -0.02 0.04 0.01 0.09 0.04 0.01 -0.09 -0.08 -0.18

39

Table 4 Creditor Rights, Recessions, and Debt Financing

This table shows regression estimates of debt financing on creditor rights, recession dummy, and firm and country controls. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. All firm control variables are lagged by one year, with the exception of cash flow, which is measured during the fiscal year. All regressions include legal origin dummies for English, French, German, and Scandinavian legal origin, quarter-year and industry dummies as well as interaction terms of these dummy variables with the recession indicator. t-statistics, computed using standard errors corrected for heteroskedasticity and clustered at the country level, are reported in parentheses. *, **, *** indicate significance at 10%, 5%, and 1%, respectively. Dependent Variable: Debt Financing (1) (2) (3) (4) Creditor Rights -0.170 -0.094 -0.205 0.916 (-1.62) (-0.79) (-2.04)** (2.87)*** Creditor Rights × Recession Dummy 0.718 0.892 0.753 0.552 (3.00)*** (2.93)*** (3.09)*** (2.16)** Legal Rights Index -0.132 (-0.76) Legal Rights Index × Recession Dummy -0.369 (-0.98) Legal Formalism 0.435 (0.99) Legal Formalism × Recession Dummy -0.437 (-1.59) Log (Total Assets) -0.435 -0.437 -0.438 -0.458 (-8.64)*** (-8.71)*** (-8.91)*** (-10.18)*** Log (Total Assets) × Recession Dummy 0.224 0.220 0.227 0.239 (2.41)** (2.42)** (2.45)** (2.69)** Tobin’s q 0.519 0.519 0.521 0.482 (6.66)*** (6.67)*** (6.66)*** (7.34)*** Tobin’s q × Recession Dummy 0.106 0.113 0.104 0.147 (0.58) (0.61) (0.57) (0.84) Cash Flow 0.357 0.379 0.339 0.555 (0.20) (0.21) (0.19) (0.30) Cash Flow × Recession Dummy -5.358 -5.421 -5.340 -5.582 (-2.50)** (-2.48)** (-2.50)** (-2.54)** Leverage -9.036 -9.048 -9.041 -9.115 (-9.24)*** (-9.25)*** (-9.24)*** (-9.44)*** Leverage × Recession Dummy 1.567 1.427 1.572 1.379 (0.86) (0.77) (0.86) (0.77) Tangibility 5.121 5.124 5.153 5.410 (5.53)*** (5.56)*** (5.67)*** (6.04)*** Tangibility × Recession Dummy -0.218 -0.121 -0.250 -0.268 (-0.30) (-0.17) (-0.35) (-0.39) Log (Initial GDP/Capita) -0.137 -0.060 -0.174 (-0.45) (-0.19) (-0.58) Log (Initial GDP/Capita) × Recession Dummy 0.147 0.249 0.183 -0.401 (0.30) (0.48) (0.35) (-0.86) Legal Origin Dummies Yes Yes Yes No Legal Origin Dummies × Recession Dummy Yes Yes Yes Yes Time Dummies Yes Yes Yes Yes Time Dummies × Recession Dummy Yes Yes Yes Yes Industry Dummies Yes Yes Yes No Industry Dummies × Recession Dummy Yes Yes Yes Yes Country Fixed Effects No No No Yes Observations 121,007 121,007 121,007 121,007 Adjusted R2 0.06 0.06 0.06 0.05 p-value of test (Creditor Rights + Creditor Rights × Recession) = 0 (0.03) (0.01) (0.03) (0.00)

40

Table 5 Creditor Rights, Real GDP Growth, and Debt Financing

This table shows regression estimates of debt financing on creditor rights, real GDP growth, and firm and country controls. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. All firm control variables are lagged by one year, with the exception of cash flow, which is measured during the fiscal year. All regressions include legal origin dummies for English, French, German, and Scandinavian legal origin, quarter-year and industry dummies as well as interaction terms of these dummy variables with the recession indicator. t-statistics, computed using standard errors corrected for heteroskedasticity and clustered at the country level, are reported in parentheses. *, **, *** indicate significance at 10%, 5%, and 1%, respectively. Dependent Variable: Debt Financing (1) (2) (3) (4) Creditor Rights 0.405 0.674 0.454 1.465 (2.86)*** (4.60)*** (3.10)*** (4.41)*** Creditor Rights × Real GDP Growth -14.139 -19.488 -17.320 -9.599 (-3.26)*** (-4.14)*** (-3.70)*** (-1.96)* Legal Rights Index -0.442 (-3.25)*** Legal Rights Index × Real GDP Growth 7.491 (2.08)** Legal Formalism -7.894 (-0.98) Legal Formalism × Real GDP Growth -0.081 (-0.33) Log (Total Assets) -0.266 -0.270 -0.264 -0.254 (-4.25)*** (-4.21)*** (-4.16)*** (-4.16)*** Log (Total Assets) × Real GDP Growth -4.752 -4.734 -4.924 -5.714 (-3.16)*** (-3.16)*** (-3.29)*** (-3.87)*** Tobin’s q 0.510 0.518 0.521 0.545 (5.51)*** (5.62)*** (5.70)*** (6.47)*** Tobin’s q × Real GDP Growth -0.586 -0.872 -0.959 -2.196 (-0.20) (-0.31) (-0.33) (-0.83) Cash Flow -0.908 -0.979 -0.907 -0.976 (-0.57) (-0.61) (-0.57) (-0.59) Cash Flow × Real GDP Growth 22.283 26.427 21.995 26.394 (0.77) (0.90) (0.76) (0.88) Leverage -8.374 -8.552 -8.400 -8.854 (-6.11)*** (-6.04)*** (-6.14)*** (-6.22)*** Leverage × Real GDP Growth -7.992 -3.376 -7.142 1.634 (-0.23) (-0.10) (-0.21) (0.05) Tangibility 5.087 5.193 5.090 5.440 (6.36)*** (6.75)*** (6.47)*** (7.00)*** Tangibility × Real GDP Growth 0.732 -1.764 1.561 -3.062 (0.08) (-0.19) (0.17) (-0.33) Log (Initial GDP/Capita) 1.143 1.430 1.121 (5.20)*** (7.37)*** (5.44)*** Log (Initial GDP/Capita) × Real GDP Growth -16.741 -21.961 -17.530 -4.856 (-3.65)*** (-5.49)*** (-4.20)*** (-0.70) Legal Origin Dummies Yes Yes Yes No Legal Origin Dummies × Real GDP Growth Yes Yes Yes Yes Time Dummies Yes Yes Yes Yes Time Dummies × Real GDP Growth Yes Yes Yes Yes Industry Dummies Yes Yes Yes No Industry Dummies × Real GDP Growth Yes Yes Yes Yes Country Fixed Effects No No No Yes Observations 121,008 121,008 121,008 121,008 Adjusted R2 0.06 0.06 0.06 0.06 p-value of test (Creditor Rights + Creditor Rights × Recession) = 0 (0.00) (0.00) (0.00) (0.11)

41

Table 6 Creditor Rights, Recessions, and the Cost of Debt

This table shows regression estimates of the cost of debt on creditor rights, recession dummy, and controls. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. All firm control variables are lagged by one year, with the exception of cash flow, which is measured during the fiscal year. All regressions include legal origin dummies for English, French, German, and Scandinavian legal origin, quarter-year and industry dummies. t-statistics, computed using standard errors corrected for heteroskedasticity and clustered at the country level, are reported in parentheses. *, **, *** indicate significance at 10%, 5%, and 1%, respectively. Dependent Variable: Cost of Debt (1) (2) (3) (4) (5) Recession Dummy 0.271 0.399 0.324 0.323 0.419 (2.47)** (3.48)*** (2.54)** (2.73)** (3.98)*** Creditor Rights -0.134 -0.054 -0.000 0.033 0.170 (-5.73)*** (-0.62) (-0.00) (1.41) (0.89) Creditor Rights × Recession Dummy -0.036 -0.144 -0.216 -0.184 -0.202 (-0.79) (-2.20)** (-3.33)*** (-2.65)** (-2.74)** Log (Initial GDP/Capita) -0.035 0.008 0.033 (-2.11)** (0.32) (1.22) Default Spread 0.272 0.423 0.638 0.673 0.572 (1.94)* (2.54)** (3.78)*** (4.23)*** (4.23)*** Term Spread -0.113 -0.093 -0.093 -0.091 -0.082 (-2.99)*** (-10.78)*** (-2.59)** (-2.42)** (-2.75)** Log (Total Assets) -0.188 -0.138 -0.138 (-6.56)*** (-6.58)*** (-6.51)*** Tobin’s q -0.011 -0.007 -0.008 (-2.29)** (-2.09)* (-1.97)* Cash Flow -0.795 -0.540 -0.345 (-2.62)** (-1.93)* (-1.10) Leverage 0.592 0.533 0.474 (2.20)** (2.10)* (1.79)* Tangibility -0.115 -0.048 -0.009 (-0.81) (-0.42) (-0.05) Log (Maturity) 0.012 0.003 (0.39) (0.13) Log (Offering Amount) -0.006 0.003 (-0.35) (0.24) Secured Bond 0.028 0.075 (0.21) (0.60) Callable Bond 0.128 0.126 (1.44) (1.26) Putable Bond -0.011 0.010 (-0.06) (0.06) High Yield Bond 0.329 0.337 (10.74)*** (8.51)*** Legal Origin Dummies Yes Yes Yes Yes No Time Dummies Yes Yes Yes Yes Yes Industry Dummies Yes Yes Yes Yes No Firm Fixed Effects No Yes No No No Country Fixed Effects No No No No Yes Observations 1,726 1,726 291 291 291 Adjusted R2 0.45 0.89 0.68 0.75 0.75 p-value of test (Creditor Rights + Creditor Rights × Recession) = 0 (0.00) (0.05) (0.00) (0.02) (0.87)

42

Table 7 Creditor Rights, Recessions, and Capital Expenditures

This table shows regression estimates of capital expenditure on creditor rights, recession dummy, and firm and country controls. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. All firm control variables are lagged by one year, with the exception of cash flow, which is measured during the fiscal year. All regressions include legal origin dummies for English, French, German, and Scandinavian legal origin, quarter-year and industry dummies as well as interaction terms of these dummy variables with the recession indicator. t-statistics, computed using standard errors corrected for heteroskedasticity and clustered at the country level, are reported in parentheses. *, **, *** indicate significance at 10%, 5%, and 1%, respectively. Dependent Variable: Capital Expenditures (1) (2) (3) (4) Creditor Rights -0.058 0.014 -0.090 0.562 (-0.57) (0.14) (-0.87) (2.38)** Creditor Rights × Recession Dummy 0.547 0.423 0.517 0.293 (5.36)*** (5.62)*** (5.39)*** (2.33)** Legal Rights Index -0.126 (-0.94) Legal Rights Index × Recession Dummy 0.228 (2.05)** Legal Formalism 0.043 (0.11) Legal Formalism × Recession Dummy -0.416 (-1.31) Log (Total Assets) -0.411 -0.413 -0.413 -0.388 (-5.91)*** (-5.96)*** (-5.95)*** (-5.89)*** Log (Total Assets) × Recession Dummy 0.209 0.213 0.206 0.194 (3.23)*** (3.32)*** (3.10)*** (2.79)*** Tobin’s q 0.642 0.642 0.644 0.624 (12.40)*** (12.36)*** (12.54)*** (11.45)*** Tobin’s q × Recession Dummy 0.014 0.013 0.013 0.018 (0.11) (0.10) (0.10) (0.14) Cash Flow 11.541 11.556 11.525 11.337 (5.34)*** (5.33)*** (5.37)*** (5.35)*** Cash Flow × Recession Dummy 3.050 3.046 3.082 3.258 (1.38) (1.38) (1.40) (1.50) Leverage -2.269 -2.283 -2.270 -2.283 (-7.20)*** (-7.30)*** (-7.13)*** (-8.33)*** Leverage × Recession Dummy 1.532 1.583 1.566 1.391 (4.94)*** (5.32)*** (5.08)*** (4.57)*** Tangibility 11.713 11.716 11.741 11.978 (10.22)*** (10.29)*** (10.42)*** (10.97)*** Tangibility × Recession Dummy -2.090 -2.114 -2.119 -2.150 (-3.91)*** (-4.06)*** (-4.01)*** (-4.17)*** Log (Initial GDP/Capita) 0.291 0.366 0.256 (1.61) (2.07)** (1.42) Log (Initial GDP/Capita) × Recession Dummy -0.546 -0.655 -0.613 -0.325 (-2.27)** (-2.75)*** (-2.25)** (-1.64) Legal Origin Dummies Yes Yes Yes No Legal Origin Dummies × Recession Dummy Yes Yes Yes Yes Time Dummies Yes Yes Yes Yes Time Dummies × Recession Dummy Yes Yes Yes Yes Industry Dummies Yes Yes Yes No Industry Dummies × Recession Dummy Yes Yes Yes Yes Country Fixed Effects No No No Yes Observations 125,658 125,658 125,658 125,658 Adjusted R2 0.28 0.28 0.29 0.26 p-value of test (Creditor Rights + Creditor Rights × Recession) = 0 (0.00) (0.00) (0.00) (0.00)

43

Table 8 Creditor Rights, Real GDP Growth, and Capital Expenditures

This table shows regression estimates of capital expenditure on creditor rights, real GDP growth, and firm and country controls. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. All firm control variables are lagged by one year, with the exception of cash flow, which is measured during the fiscal year. All regressions include legal origin dummies for English, French, German, and Scandinavian legal origin, quarter-year and industry dummies as well as interaction terms of these dummy variables with the recession indicator. t-statistics, computed using standard errors corrected for heteroskedasticity and clustered at the country level, are reported in parentheses. *, **, *** indicate significance at 10%, 5%, and 1%, respectively. Dependent Variable: Capital Expenditure (1) (2) (3) (4) Creditor Rights 0.218 0.266 0.289 0.734 (1.50) (2.20)** (1.88)* (3.08)*** Creditor Rights × Real GDP Growth -8.258 -7.197 -12.215 -2.238 (-3.13)*** (-2.84)*** (-4.35)*** (-1.11) Legal Rights Index -0.111 (-0.81) Legal Rights Index × Real GDP Growth -0.867 (-0.72) Legal Formalism -10.622 (-2.50)** Legal Formalism × Real GDP Growth 0.010 (0.03) Log (Total Assets) -0.291 -0.292 -0.289 -0.263 (-3.15)*** (-3.17)*** (-3.17)*** (-3.15)*** Log (Total Assets) × Real GDP Growth -3.363 -3.382 -3.497 -3.582 (-2.32)** (-2.34)** (-2.53)** (-2.80)*** Tobin’s q 0.575 0.576 0.589 0.587 (6.41)*** (6.38)*** (6.60)*** (6.97)*** Tobin’s q × Real GDP Growth 1.668 1.654 1.196 0.925 (0.98) (0.97) (0.72) (0.61) Cash Flow 11.551 11.560 11.535 11.302 (5.74)*** (5.72)*** (5.75)*** (5.76)*** Cash Flow × Real GDP Growth 10.459 10.317 10.708 10.157 (0.61) (0.60) (0.62) (0.63) Leverage -1.825 -1.853 -1.876 -2.054 (-4.25)*** (-4.23)*** (-4.33)*** (-5.48)*** Leverage × Real GDP Growth -5.475 -5.319 -3.732 -1.248 (-0.84) (-0.79) (-0.58) (-0.20) Tangibility 10.967 10.981 10.966 11.319 (9.99)*** (10.05)*** (10.12)*** (10.85)*** Tangibility × Real GDP Growth 15.814 15.500 16.798 12.415 (1.44) (1.39) (1.56) (1.16) Log (Initial GDP/Capita) 0.743 0.783 0.731 (3.77)*** (3.90)*** (3.73)*** Log (Initial GDP/Capita) × Real GDP Growth -3.156 -2.159 -4.249 1.082 (-1.33) (-0.96) (-1.94)* (0.47) Legal Origin Dummies Yes Yes Yes No Legal Origin Dummies × Real GDP Growth Yes Yes Yes Yes Time Dummies Yes Yes Yes Yes Time Dummies × Real GDP Growth Yes Yes Yes Yes Industry Dummies Yes Yes Yes No Industry Dummies × Real GDP Growth Yes Yes Yes Yes Country Fixed Effects No No No Yes Observations 125,659 125,659 125,659 125,659 Adjusted R2 0.29 0.29 0.29 0.27 p-value of test (Creditor Rights + Creditor Rights × Recession) = 0 (0.00) (0.01) (0.00) (0.47)

44

Table 9 Creditor Rights, Recessions, and Debt Financing: Agency Cost Subsamples

This table shows regression estimates of debt financing on creditor rights, recession dummies, and firm and country controls. This table reports regression results for subsamples of firms with high and low expected agency costs. We measure agency costs with leverage and revenue. The “High Leverage” subsample consists of firms that have a leverage that is greater than the industry median. Firms with a leverage greater than 40% (50%) are included in the subsample “Leverage > 40%” (“Leverage > 50%”). The “Low Revenue” subsample consists of firms that have sales-to-PPE less than the industry median. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. All firm control variables are lagged by one year, with the exception of cash flow, which is measured during the fiscal year. All regressions include legal origin dummies for English, French, German, and Scandinavian legal origin, quarter-year and industry dummies as well as interaction terms of these dummy variables with the recession indicator. t-statistics, computed using standard errors corrected for heteroskedasticity and clustered at the country level, are reported in parentheses. *, **, *** indicate significance at 10%, 5%, and 1%, respectively. High

Leverage Low

Leverage Leverage

> 40% Leverage

≤ 40% Leverage

> 50% Leverage

≤ 50% Low

Revenue High

Revenue (1) (2) (3) (4) (5) (6) (7) (8) Creditor Rights -0.364 -0.041 -0.504 -0.084 -0.814 -0.103 -0.253 -0.077 (-1.64) (-0.52) (-1.49) (-0.78) (-1.54) (-0.90) (-1.57) (-0.77) Creditor Rights × Recession 1.166 0.399 1.590 0.492 1.792 0.610 1.082 0.422 (2.99)*** (2.78)*** (2.26)** (2.99)*** (1.88)* (3.19)*** (2.75)*** (2.16)** Firm and Country Controls Yes Yes Yes Yes Yes Yes Yes Yes Firm and Country Controls × Recession Yes Yes Yes Yes Yes Yes Yes Yes Time Dummies Yes Yes Yes Yes Yes Yes Yes Yes Time Dummies × Recession Yes Yes Yes Yes Yes Yes Yes Yes Industry Dummies Yes Yes Yes Yes Yes Yes Yes Yes Industry Dummies × Recession Yes Yes Yes Yes Yes Yes Yes Yes Observations 60,494 60,513 22,423 98,584 11,361 109,646 60,328 60,341 Adjusted R2 0.07 0.04 0.11 0.04 0.13 0.04 0.07 0.04 p-value of test (Creditor Rights + Creditor Rights × Recession) = 0 (0.03) (0.01) (0.07) (0.02) (0.25) (0.01) (0.03) (0.08)

p-value of test that the coefficients on Creditor Rights × Recession is different between the two subsamples

(0.03)

(0.09)

(0.17)

(0.05)

45

Table 10 Creditor Rights, Recessions, and Capital Expenditure: Agency Cost Subsamples

This table shows regression estimates of capital expenditure on creditor rights, recession dummies, and firm and country controls. This table reports results for subsamples of firms with high and low expected agency costs. We measure agency costs with leverage and revenue. The “High Leverage” subsample consists of firms that have a leverage that is greater than the industry median. Firms with a leverage greater than 40% (50%) are included in the subsample “Leverage > 40%” (“Leverage > 50%”). The “Low Revenue” subsample consists of firms that have sales-to-PPE less than the industry median. The sample period is 1980 to 2003. Countries with less than three years of data are dropped. The variables are described in Table 1. All firm control variables are lagged by one year, with the exception of cash flow, which is measured during the fiscal year. All regressions include legal origin dummies for English, French, German, and Scandinavian legal origin, quarter-year and industry dummies as well as interaction terms of these dummy variables with the recession indicator. t-statistics, computed using standard errors corrected for heteroskedasticity and clustered at the country level, are reported in parentheses. *, **, *** indicate significance at 10%, 5%, and 1%, respectively. High

Leverage Low

Leverage Leverage

> 40% Leverage

≤ 40% Leverage

> 50% Leverage

≤ 50% Low

Revenue High

Revenue (1) (2) (3) (4) (5) (6) (7) (8) Creditor Rights -0.051 -0.081 0.097 -0.082 0.049 -0.061 -0.072 0.019 (-0.55) (-0.81) (0.86) (-0.83) (0.45) (-0.62) (-0.60) (0.23) Creditor Rights × Recession 0.627 0.541 0.752 0.537 1.172 0.532 0.625 0.429 (5.55)*** (4.50)*** (3.30)*** (5.67)*** (3.42)*** (5.64)*** (5.12)*** (4.22)*** Firm and Country Controls Yes Yes Yes Yes Yes Yes Yes Yes Firm and Country Controls × Recession Yes Yes Yes Yes Yes Yes Yes Yes Time Dummies Yes Yes Yes Yes Yes Yes Yes Yes Time Dummies × Recession Yes Yes Yes Yes Yes Yes Yes Yes Industry Dummies Yes Yes Yes Yes Yes Yes Yes Yes Industry Dummies × Recession Yes Yes Yes Yes Yes Yes Yes Yes Observations 62,822 62,836 26,258 99,400 13,478 112,180 62,674 62,689 Adjusted R2 0.28 0.29 0.25 0.30 0.25 0.30 0.29 0.31 p-value of test (Creditor Rights + Creditor Rights × Recession) = 0 (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00) (0.00)

p-value of test that the coefficients on Creditor Rights × Recession is different between the two subsamples

(0.47)

(0.36)

(0.08)

(0.13)

46

Figure 1. Creditor Rights, Recessions, and Debt Financing. The figure shows debt financing for different creditor rights scores during recessions (red) and expansions (blue). The dashed lines represent the 95%-confidence interval. The numbers are estimated based on the results of model 1 of Table 4, using marginal effects.

-2.0

-1.0

0.0

1.0

2.0

3.0

4.0

0 1 2 3 4

Debt

Fin

anci

ng

Creditor Rights

Expansions

Recessions

47

Figure 2. Creditor Rights, Recessions, and Capital Expenditures. The figure shows capital expenditure for different creditor rights scores during recessions (red) and expansions (blue). The dashed lines represent the 95%-confidence interval. The numbers are estimated based on the results of model 1 of Table 7, using marginal effects.

5.0

5.5

6.0

6.5

7.0

7.5

8.0

0 1 2 3 4

Capi

tal E

xpen

ditu

re

Creditor Rights

Recessions

Expansions

48

Figure 3. The Use of Covenants for U.S. Corporate Bonds during Expansions and Recessions. This figure provides a comparison of the use of covenants during expansions and recessions by Moody’s bond ratings. The sample contains 46,141 U.S. corporate bonds issued from 1990 to 2008. The gray bars indicate expansion periods, while the red bars represent recession periods. The bond ratings range from 2 (C) to 22 (Aaa). Bonds with ratings equal or below 11 (Ba2) are considered highyield bonds. The data are from FISD.

02

46

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Expansions Recessions

can bankruptcy laws mitigate business cycles? evidence from … · 2014. 5. 7. · bernanke and...

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