Debt enforcement, financial leverage, and product failures: Evidence from China and the United States

Abstract

Building on capital structure and product market interactions, and the role of debt enforcement in leveraged firms' investments, we examine whether cross-country debt enforcement can produce different associations between financial leverage and product failures. Results show that different debt enforcement systems can generate opposite leverage effects. In countries with weak/nearly ineffective debt enforcement, financial leverage shows an incentive investment effect due to low default costs, and thus highly leveraged firms tend to invest more and are less likely to have product failures. Conversely, in countries with strict/effective debt enforcement, distressed companies tend to have an underinvestment effect and more product failures.