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Does litigation risk matter for the choice between bank debt and public debt?

Author

Listed:
  • Baker, H. Kent
  • Rjiba, Hatem
  • Saadi, Samir
  • Sassi, Syrine

Abstract

We examine the impact of liberal judge ideology, as an exogenous proxy for litigation risk, on firms' choice of debt structure. In line with the substitution of governance mechanisms hypothesis, we find that U.S. firms headquartered in circuits dominated by liberal judges rely less on bank debt financing. We also show that the substitution away from bank borrowing arising from liberal judge ideology leads to a greater reliance on other financing alternatives, such as public debt and equity financing. Additional analyses indicate that the effect of liberal judge ideology is amplified for firms operating in competitive markets, firms facing tighter financial constraints, and firms with more growth opportunities. The governance substitution effect is, however, less pronounced for firms with higher institutional ownership. Overall, our findings suggest that, by exacerbating litigation risk, liberal judge ideology induces firms to trade-off creditor governance stemming from bank debt with governance by litigation, thus decreasing their reliance on bank debt in favor of alternative financing sources with less strict constraints and lower monitoring of managerial behavior.

Suggested Citation

  • Baker, H. Kent & Rjiba, Hatem & Saadi, Samir & Sassi, Syrine, 2024. "Does litigation risk matter for the choice between bank debt and public debt?," Journal of Corporate Finance, Elsevier, vol. 89(C).
  • Handle: RePEc:eee:corfin:v:89:y:2024:i:c:s0929119924001500
    DOI: 10.1016/j.jcorpfin.2024.102688
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    More about this item

    Keywords

    Litigation risk; Judge ideology; Debt structure; Monitoring; Corporate governance;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • K22 - Law and Economics - - Regulation and Business Law - - - Business and Securities Law
    • K41 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Litigation Process

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