The Dark-Side Effects of Creditor Rights: Evidence from Capital Structure and Product Market Interactions

Abstract

An extensive body of international business research examines how cross-country variations in legal institutions influence corporate finance practices. Building on this literature, as well as the literature on capital structure and product market interactions, we investigate the effect of an important dimension of legal institutions – creditor rights – on the product market performance of highly leveraged firms. Using a sample of 37,422 firms from 60 countries over the 1989–2016 period, we find that strong creditor protection benefits less leveraged firms, but adversely affects highly leveraged firms by increasing the adverse responses of customers, competitors, and employees. The adverse effect of creditor rights on the costs of high leverage is more pronounced for firms in countries with developed debt markets and banking systems, but mostly insignificant for firms in countries with developed equity markets and low information asymmetry. Our study offers new insights to the international business literature and contributes to the debate on the role of creditor protection by uncovering a potential cost based on capital structure and product market interactions.