Judicial Reform, Creditor Rights, and Innovation: A Quasi-Random Experiment of China's Specialized Court Reform
XU Nianhang, WANG Chongjun, ZHANG Jichao
School of Business, Renmin University; Postdoctoral Station of China Cinda Asset Management Co., Ltd.; Postdoctoral Station of National Development and Strategic Research Institute of Renmin University
Summary:
Corporate innovation plays a key role in a firm's growth and is the engine of national economic growth. Due to the high levels of uncertainty and R&D investment involved, a prerequisite for the success of corporate innovation is a stable and abundant financing source. Unlike in many Western countries, debt financing in China constitutes the largest proportion of total financing, and thus the support from creditors is critical to the success of corporate innovation. However, debt holders receive fixed incomes from the interest so they cannot benefit from a firm's risk-taking activities such as innovation. They will then suffer losses if these firms go bankrupt due to the failure of their innovation. They will then hold a negative attitude toward such activities. The judicial capacity of the court regarding bankruptcy generally has a profound impact on creditors' failure tolerance and corporate innovation activities. Long trial times and ignorance of creditors' legal rights can significantly affect bankruptcy costs. The literature on bankruptcy institutions and corporate innovation primarily focuses on the impact of legislation, and thus we advance the literature by examining the impact of law enforcement on corporate activities. We investigate how judicial capacity affects the innovation activities of local firms by regarding the introduction of a specialist tribunal for liquidation and bankruptcy as a quasi-random experiment. We find that after the local courts establish such a tribunal, local firms significantly increase their R&D intensity from 14.00% to 15.95% compared with non-local firms. The findings are robust to various checks, such as a matched sample using propensity score matching and using the distance between the city and universities with doctoral degrees conferring places in first-level disciplines in law as an instrumental variable. The impact of the reform on corporate innovation is more pronounced for firms located in provinces with less relevant judicial specialization, firms more heavily supervised by creditors, and those whose creditors have a lower tolerance of failure. We further find that the reform significantly decreases the processing time of local listed firms' bankruptcy cases. It also enhances the debt financing capabilities and reduces the interest rates of local firms' corporate bond issuance. In addition, heterogeneity tests show that the impact is stronger for firms that are less likely to go bankrupt and those located in cities with more zombie firms. Finally, we find that innovation output, as measured by patent applications from local firms, also increases significantly after the reform. The paper makes several contributions to the literature. First, we contribute to research on how institutions dealing with bankruptcy affect corporate innovation activities. Unlike other studies that analyze the impact of legislation on innovation activities, we examine the impact of bankruptcy law enforcement in the unique context of China's specialized court reform. Second, we contribute to the literature on the economic effects of courts and their organizational structures. The court plays an important role in determining the level of law enforcement. The economic outcome of judicial organizational reform such as the introduction of a specialized tribunal has drawn much attention from academia. Unlike other types of cases, the complexity of bankruptcy cases means that the courts' capacity to ensure judicial quality and efficiency is of great importance. We contribute to this strand of literature by providing new evidence from specialized bankruptcy courts. Finally, our study offers a novel approach to examining the relationship between judicial capacity regarding bankruptcy and corporate innovation in the form of a quasi-natural experimental setting, which can help to alleviate any endogeneity concerns. Our study has several important policy implications. First, it demonstrates that specialized court reform can significantly enhance the efficiency and professionalism of law enforcement, and thus provides an important reference for other bankruptcy case trial reforms. Second, we reveal that a well-functioning institution that focuses on bankruptcy can help to achieve a good business environment and market operation. Such institutions are significant in promoting micro-enterprise innovation and supporting financial services in the real economy. Third, our findings provide useful implications for China's implementation of national strategies for law-based governance and innovation-driven development.
Acharya, Viral V., and Subramanian Krishnamurthy V. 2009. “Bankruptcy Codes and Innovation”, Review of Financial Studies, 22(12):4949～4988.
[17]
Bernile, Gennaro, Bhagwat Vineet, and Rau P. Raghavendra. 2017. “What Doesn't Kill You Will Only Make You More Risk-Loving: Early-Life Disasters and CEO Behavior”, Journal of Finance, 72(1):167～206.
[18]
Caskey, Judson, and Ozel N. Bugra. 2017. “Earning Expectations and Employee Safety”, Journal of Accounting and Economics, 63(1):121～141.
[19]
Colonnelli, Emanuele, and Prem Mounu. 2021. “Corruption and Firms”, The Review of Economic Studies, 89(2):695～732.
[20]
Glaeser, Stephen. 2018. “The Effects of Proprietary Information on Corporate Disclosure and Transparency: Evidence from Trade Secrets”, Journal of Accounting and Economics, 66(1):163～193.
[21]
Glaeser, Edward L, and Lu Ming. 2018. “Human-Capital Externalities in China”, Harvard University Working Paper.
[22]
Holmstrom, Bengt. 1989. “Agency Costs and Innovation”, Journal of Economic Behavior & Organization, 12(3):305～327.
[23]
Iverson, Benjamin. 2018. “Get in line: Chapter 11 Restructuring in Crowded Bankruptcy Courts”, Management Science, 64(11):5370～5394.
[24]
La Porta, Rafael, Lopez-de-Silanes Florencio, Shleifer Andrei, and Vishny Robert. 2000. “Investor Protection and Corporate Governance”, Journal of Financial Economics, 58(1-2):3～27.
[25]
Li, Bo, and Ponticelli Jacopo. 2022. “Going Bankrupt in China”, Review of Finance, 26(3):449～486.
[26]
Manson, Gustavo. 2011. “Motivating Innovation”, Journal of Finance, 66(5):1823～1860.
[27]
Tarantino, Emanuele. 2013. “Bankruptcy Law and Corporate Investment Decisions”, Journal of Banking & Finance, 37(7): 2490～2500.
[28]
Visaria, Sujata. 2009. “Legal Reform and Loan Repayment: The Microeconomic Impact of Debt Recovery Tribunals in India”, American Economic Journal: Applied Economics, 1(3): 59～81.
