Collateral Damaged? Priority Structure, Credit Supply, and Firm Performance

We exploit a legal reform in Sweden that reduces the liquidation value of assets for the lenders without affecting their value for the borrowers. Using a panel of all firms registered in Sweden, we find that the loss in liquidation value reduces the amount and maturity of firm debt and leads firms to reduce investment and growth. The reform further alters asset allocation, as firms reduce their holdings of assets with low collaterizable value and hoard more cash. However, the reform has no impact on capital intensity or efficiency, suggesting firms simply scale down operations under these newly-binding credit constraints.