Article: article from journal or magazin.
Law Enforcement, Firms and Capital Accumulation: Theory and Evidence
Under revision for the Journal of the European Economic Association
This paper investigates the economic effects of differences in the degree of enforcement of laws on firms' policies by exploiting within-country variability in the behavior of judicial districts. After controlling for several firm's characteristics, for the degree of concentration in the banking industry, for economic development and heterogeneity at the regional level, we document that firms located in judicial districts where trials are longer, have access to lower and more costly external financing from the banking sector and have a smaller size. However, we do not find any significant relation between the degree of legal enforcement and the firm's leverage ratio. We propose a theoretical explanation for our results based on a two-region dynamic general equilibrium model with two-period overlapping generations, asymmetric information, and collateralized credit contracts. This analysis shows that a stronger protection of creditors' rights induces important general equilibrium effects, like wage adjustments and changes in the individual capital accumulation, which are the driving forces in our model. A conclusive test confirms that the mechanisms behind our empirical evidence are indeed the ones suggested by our theoretical model.
Z3, Judicial enforcement, External finance, Leverage ratio, Firm size, Cost of credit, Aggregate activity.
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