Does bankruptcy law affect the relation between leverage and firm performance?

Purpose

The purpose of this paper is to examine the impact of bankruptcy reform in the year 2016 on the relation between leverage and firm performance for Indian firms, separately for business group and standalone firms.

Design/methodology/approach

Fixed effects panel regression is used to understand the role of bankruptcy reform on firm-level data to examine the relationship between leverage and firm performance after controlling for size, growth, age, liquidity and promoter shareholding. The authors also apply the generalized method of moments (GMM) to control for the endogeneity concerns.

Findings

The authors show that the introduction of the insolvency and bankruptcy code (IBC) positively moderates the relation between leverage and firm performance such that the extent of negative relation between leverage and firm performance is less in the post-IBC period. The positive impact of IBC on the relation between leverage and firm performance holds only for firms not affiliated to business groups and for firms with higher debt in their capital structure.

Practical implications

The study’s findings will help the regulators appreciate the effectiveness of bankruptcy reforms resulting from IBC implementation in terms of sound bankruptcy process and leading to safeguard the interests of minority shareholders.

Originality/value

The authors provide the only study to examine the role of bankruptcy law in moderating the relation between leverage and firm performance across a sample of business group and standalone firms.