The Role of Creditor Rights on Capital Structure and Product Market Interactions: International Evidence

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 while strong creditor protection benefits less leveraged firms, it adversely affects the product market performance of highly leveraged firms, by increasing the adverse responses of customers, competitors, and employees of these firms. When we further examine cross-country variations, we find that 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, while it is mostly insignificant for firms in countries with developed equity markets and low information asymmetry. This evidence is not driven by highly leveraged firms exhibiting poor managerial quality or poor performance, and non-randomly distributed across strong and weak creditor rights countries. Our evidence contributes to the debate on the role of creditor protection by uncovering a potential cost based on capital structure and product market interactions.