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Law Enforcement and Firm Financing: Theory and Evidence

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  • Daniela Fabbri

Abstract

This paper investigates the economic effects on firms' policies of differences in law enforcement. We find that in judicial districts where trials are longer, bank financing is more costly and firms are smaller. However, we do not find any significant relation between law enforcement and firms' leverage ratio. We rationalize our results within a two-region dynamic general equilibrium model with asymmetric information and collateralized credit contracts. We find that a stronger enforcement of creditors' rights not only improves credit conditions (partial equilibrium effect), but also fosters individual capital accumulation (general equilibrium effect). In line with this theoretical prediction, we find a positive relation between individual savings and quality of legal enforcement. (JEL: E20, K40, G32) (c) 2010 by the European Economic Association.

Suggested Citation

  • Daniela Fabbri, 2010. "Law Enforcement and Firm Financing: Theory and Evidence," Journal of the European Economic Association, MIT Press, vol. 8(4), pages 776-816, June.
    • Handle: RePEc:tpr:jeurec:v:8:y:2010:i:4:p:776-816
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    JEL classification:

    • E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
    • K40 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - General
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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