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Law and finance: Firm-creditor relationships, legal institutions, and corporate policies
Stiftungen - Sonstige;
This research project aims at studying how corporate governance affects firm value and policies, with a focus on firm-creditor relationships and legal institutions. Traditionally, finance-oriented empirical corporate governance research has focused on mechanisms aimed at reducing conflicts between management and shareholders. Interestingly, a large theoretical literature shows that creditors may play an important role in corporate governance even outside of default states. Yet, despite receiving more attention recently, the issue remains relatively underexplored on the empirical side. Another form of governance that remains underexplored is the court system. A well-functioning court system is deemed to be of primary importance for businesses and the economy as a whole by providing timely, competent and unbiased resolution of legal disputes. The goal is thus to understand the role of these governance mechanisms and how recent legal and financial developments interact with them. We plan to investigate these issues along three lines of research.

First, we will look at how financial and legal innovations impact firm-creditor relationships. We plan to empirically examine how the possibility to hedge against credit risk on a firm's debt through credit default swaps (CDS) may alter such relationships by reducing creditors' incentives to monitor the firm. The goal is to understand if creditors reduce their involvement in internal governance and if shareholders adjust other governance mechanisms as a consequence. Moreover, we intend to analyze the real effects of credit derivatives by studying how the availability of CDSs affects corporate investment depending on the ex ante shareholder-creditor balance of power. We will also study the real effects of the changes in firm-creditor relationships induced by the formation of universal banks. If market imperfections make the supply of capital not perfectly elastic, then the formation of universal banks will affect borrowing firms' investment through its impact on the availability of external finance. A positive effect on investment should be observed if universal banks improved firms' access to finance. On the other hand, once they become universal, commercial banks may transition from relational to transactional lending, thus weakening existing bank-firm relationships. Such a transition could be particularly detrimental to opaque borrowers, which rely more on relationship lending. We therefore analyze the immediate effect of the formation of universal banks on the investment policy of non-financial public corporations, paying particular attention to firms that do not access the public debt market.

The second line of research will explore theoretically and empirically how the dynamics of debtor-creditor conflicts shape managerial incentives, and how these in turn influence the firm's cost of debt. We will examine how a firm's exposure to the business cycle influences debtor-creditor conflicts and managerial equity-based incentives. Then, we will study how the composition of managerial compensation affects risk-taking incentives and, in turn, the firm's credit risk. More precisely, we plan to investigate the effect on credit spreads of managerial debt-like compensation, a form of compensation that is deemed to mitigate debtor-creditor conflicts.

The third line of research relates to the role of the court system for firms. The outcome of a legal dispute has two main sources: The applicable laws and the courts that enforce them. A particular challenge in comparing legal systems across countries (or states within federal systems) is that any two countries (or states) will not just feature different court systems but will necessarily also enforce different laws. We aim to overcome this issue by designing empirical strategies that will allow us to identify the effect of courts on firm value and real corporate policies.


Corporate Governance, Court System, Credit Default Swaps, Empty Creditors, Executive Compensation, Inside Debt, Investment Policy, Relationship Banking, Risk-Taking