Banking Relationships And Creditor Rights
Author(s) Vidhan K. Goyal, S. Lakshmi Naaraayanan and Anand Srinivasan


Do the legal rights of creditors influence whether firms borrow from arm’s length or relationship lenders in a country? We examine this question by exploiting the staggered adoption of legal reforms that changed creditor rights. We find that as creditor rights strengthen, firms exhibit a greater propensity to switch to relationship lenders. Conversely, firms switch to arm’s length lenders as creditors rights weaken. These results are consistent with the view that arm’s length creditors have a bias towards excessive liquidation in environments with strong creditor rights. Hence as creditor rights strengthen, firms switch to relationship lenders as they are less likely to sub-optimally liquidate the firm when continuation is more efficient.

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