Creditor Rights and Corporate Risk-Taking

Acharya, V V, Amihud, Y and Litov, L (2008) Creditor Rights and Corporate Risk-Taking. Working Paper. London Business School IFA Working Paper.

Abstract

We propose that stronger creditor rights in bankruptcy reduce corporate risktaking. Employing countrylevel data, we find that strong creditor rights are associated with a greater propensity of firms to engage in diversifying mergers, and this propensity changes in response to changes in the country creditor rights. Also, in countries with stronger creditor rights companies' operating risk is lower, and acquirers with lowrecovery assets perfer targets with highrecovery assets. These relationships are strongest in countries where management is dismissed in reorganization, suggesting an agencycost effect. Our results suggest that there might be a "dark" side to strong creditor rights in that they can induce costly risk avoidance in corporate policies. Thus, stronger creditor rights may not necessarily be optimal.