The nexus of judicial efficiency, social burden and default risk: Cross-country evidence

Abstract

The paper investigates heterogeneous institutional costs related to firm bankruptcy and default risk over a comprehensive sample of 65 economies between 2003 and 2016. We find that corporate default risk is decreasing in judicial efficiency whereas it is increasing in potential social costs related to high unemployment rate. In the cross-sectional comparison, we find that firms with less cash reserves are more likely affected by judicial efficiency. Similarly, the impact of potential social costs induced by employment regulation is more pronounced in firms with higher staff expenses. Our main findings indicate that creditor protection is a crucial channel to lower corporate default risk, through which judicial efficiency alleviates the pressure from accelerating debt repayment. Besides, pro-labor regulations imposed by local governments facing high unemployment make it difficult for firms to reconcile the conflicts of labor input. It is conditional on contextual factors that whether the two types of institutional costs are complementary on default risk.