Creditor Rights, Risk Aversion, and Justice

A paper from Viral Acharya, Yakov Amihud, and Lubomir Litov shows something which makes a lot of intuitive sense: if you beef up creditor rights, you beef up corporate risk-aversion -- and that can be bad for growth. They conclude:

Our results suggest that there might be a dark side to strong creditor rights in that they can induce costly risk avoidance in corporate policies. Thus, stronger creditor rights may not necessarily be optimal.

Elizabeth Warren applies this result to the US:

Efforts by Congress, by the IMF, and by big secured creditors who press for laws to give a handful of creditors the whip hand seem short-sighted to me. Whether a policymaker is sympathetic to debtors or creditors, a bankruptcy system that encourages beneficial risk-taking, that keeps corporations searching out new business opportunities, that encourages entrepreneurs to form small businesses, and that gives consumers a reason to go to work every morning is better for everyone--debtors, creditors and all the rest of us.

I'm a little puzzled by her reference here to the IMF. "For years," she says, "lenders and the IMF have told developing countries that if they really want economic growth they need to adopt strong creditor-protection laws."

Is this true? If it is, it's deplorable. What developing countries really need is not strong creditor-protection laws or a more debtor-friendly bankruptcy system so much as a level playing field and predictability. The problem which lenders have with many developing countries is not that the official laws are creditor-unfriendly, so much as that they're in practice largely unenforceable. If the lender is a foreign bank and the borrower is a politically-connected local businessman, creditors often find themselves unable to enforce through the domestic courts the explicit terms of their loans.

The first job, then, in building a bankruptcy system is to build an independent and blind justice system. Only then is it worth worrying overmuch about tweaking the system more in favor of lenders or borrowers.

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