Bankruptcy Codes and Innovation

Acharya, V and Subramanian, K (2007) Bankruptcy Codes and Innovation. Working Paper. London Business School IFA Working Paper.

Abstract

Do legal institutions governing ficial 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 creditorfriendly, excessive liquidations cause levered firms to shy away from innovation. In contrast, by promoting continuation upon failure, a debtorfriendly code induces greater innovation. Employing patents as a proxy for innovation, we find support for the real as well as ficial 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) Timeseries changes in creditor rights within a country confirm this differenceofdifference 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.