Creditor Protection, Ease of Repossession, and the Cost of Equity Capital: Evidence from Quasi-natural Experiments

Abstract

We document that shareholders respond to strengthening of creditor rights after the staggered adoption of anti-recharacterization laws across various U.S. states by reducing the cost of equity capital. This effect is more pronounced among firms that are financially constrained, have more growth opportunities, and weaker corporate governance. We further find that the adoption of such laws directly lowers information asymmetry, overall firm risk, and leads to a more dispersed debt structure. These results suggest that strengthening of creditor rights leads to improved financing capacity and creditor monitoring, and shareholders benefit from it.