How do creditor rights matter for debt finance?

In the history of famous feuds, there are the Hatfields and the McCoys, the Montagues and the Capuletsand, sometimes it seems, lawyers and economists.

As a lawyer, I often find myself in heated debates with my economist friends and colleagues. Where they use data, we use words; where they have faith in rational actors, we know that humans are, sadly, often deeply irrational; and where they want to connect different data points to illustrate a trend, we want to highlight the infinite nuance between those data points that insists against a simple narrative.

Yet, despite our seemingly fundamental differences, we do seem to be coming together around the notion that law does matter for finance.  Specifically, that certain kinds of laws (those around creditor rights and insolvency) matter for certain kinds of finance (debt).

In a new paper, published by the European Bank for Reconstruction and Development, my colleague Antonia Menezes and I partnered with two Oxford University scholars, John Armour and Kristin van Zwieten, to show how financial infrastructure laws influence debt finance.

In the interest of full disclosure, I will tell you that all four of us are lawyers. However, John and Kristin are leading academics at the intersection of economics and law in Oxford’s Law and Finance program, and both have advanced degrees in economics.  They can talk the talk and walk the walk!

In the paper, we find that, perhaps paradoxically, strengthening the rights of creditors – including sometimes at the expense of debtor rights – can improve access to credit at reasonable rates for those very debtors.  The predictability generated by more efficient and transparent insolvency and movable collateral regimes, in particular, seem to have the effect – both in cross-country and, crucially, in within-country studies – of reducing the cost of borrowing for firms and increasing their access to finance.

Of course – as any good lawyer will tell you – caution should be used in drawing conclusions from one legal system and applying them to another one. But the evidence from a variety of different countries, across income levels and legal origins, all seems to be pointing in the same direction.

Could this herald a détente in the feud? Maybe. (Still, if I ever run into those Freakonomics guys on the street, I’m going to give them a piece of my mind. . . . )

This post first appeared on The World Bank Private Sector Development Blog.

Publication does not imply endorsement of views by the World Economic Forum.

To keep up with the Agenda subscribe to our weekly newsletter.

Author: Mahesh Uttamchandani is the Global Solutions Lead for Credit Infrastructure in the Finance and Markets Global Practice.

Image: A businessman walks on the esplanade of La Defense, in the financial and business district in La Defense, west of Paris.   REUTERS/Gonzalo Fuentes