Abstract
Using data on defaulting firms in China, we show that government intervention distorts the discipline imposed by creditors. This paper examines the impact of government intervention on leverage adjustment speed and firm performance of defaulting firms, using non-defaulting firms as the baseline. Defaulting firms have slower leverage adjustment speeds than non-defaulting firms because creditors will constrain these firms by tightening up the loan contracts. In China, local governments have incentives to bail out defaulting firms. Government intervention, by relieving loan constraints and providing subsidies, accelerates leverage adjustment speed for defaulting firms. However, higher government intervention leads to worse performance and overinvestment problems of defaulting firms. This paper indicates that government intervention can rescue and relieve firm financial constraints during an individual debt crisis. However, it can mute the disciplinary role of creditors and distort resources allocation, thus hurting firm performance.
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