An agency cost channel from creditor rights reforms to leverage

Biswajit Banerjee and Risto Herrala

No 6/2025, BOFIT Discussion Papers from Bank of Finland Institute for Emerging Economies (BOFIT)

Abstract: The paper investigates the influence of creditor rights reforms on leverage. Based on a partial equilibrium agency cost model, we propose a novel channel running from the owner/manager's private bankruptcy costs to leverage. Such costs mitigate the firms' agency problem toward creditors, thereby increasing credit limits and leverage. The proposition is tested with data from India 2011-2020, a period that saw the strengthening of creditor rights. We find that the reform caused leverage to fall, which is indicative of a decrease in owner/manager's bankruptcy costs. We also find evidence of a decline in credit limits as predicted by the proposed theory.

Keywords: Creditor rights; Leverage; Indian economy; Insolvency and bankruptcy code (search for similar items in EconPapers)
JEL-codes: C21 D22 G33 K35 (search for similar items in EconPapers)
Date: 2025
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