The bulk of capital provided to Dutch housing corporations is explicitly guaranteed by a bailout clause. Using a dataset with loans provided by the largest Dutch public sector bank (BNG Bank), we find substantial evidence that this bailout clause has reduced interest rates by about 72 basis points. The annual benefits of reduced interest costs outweigh the costs of default. We also find that the interest rates for guaranteed loans are insensitive to the financial position of corporations. We therefore surmise that the bank relied on the bailout clause. Finally, the bailout clause for corporations (which guarantees individual loans) and the one for municipalities (which entirely protects municipalities from defaulting) lead to a similar reduction in interest.

The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those oftbe IMF or IM:F policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate. This paper reexamines the empirical relationship between financial development and economic growth. It presents evidence based on cross-section and panel data using an updated dataset, a variety of econometric methods, and two standard measures of financial development: the level of liquid liabilities of the banking system and the amount of credit issued to the private sector by banks and other financial institutions. The paper identifies two sets of findings. First, in contrast with the recent evidence of Levine, Loayza, and Beck (2001), cross-section and panel-data-instrurnental-variables regressions reveal that the relationship between financial development and economic growth is, at best, weak. Second, there is evidence ofnonlinearities in the data, suggesting that finance matters for growth only at intermediate levels of financial development. Moreover, using a procedure appropriately designed to estimate long-run relationships in a panel with heterogeneous slope coefficients, there is no clear indication that finance spurs economic growth. Instead, for some specifications, the relationship is, puzzlingly, negative.

This is the accepted version of the paper.This version of the publication may differ from the final published version. Permanent AbstractWe show that the prospect of a debt renegotiation favorable to shareholders reduces the Örmís equity risk. The equity beta and return volatility are lower in countries where the bankruptcy code favors debt renegotiations and for Örms with more shareholder bargaining power relative to debt holders. These relations weaken as the countryís insolvency procedure favors liquidations over renegotiations. In the limit, when debt contracts cannot be renegotiated, the equity risk is independent of shareholdersí incentives to default strategically. We argue that these Öndings support the hypothesis that the threat of strategic default can reduce the Örmís equity risk.

We argue that the prospect of an imperfect enforcement of debt contracts in default reduces shareholder-debtholder conflicts and induces leveraged firms to invest more and take on less risk as they approach financial distress. To test these predictions, we use a large panel of firms in 41 countries with heterogeneous debt enforcement characteristics. Consistent with our model, we find that the relation between debt enforcement and firms' investment and risk depends on the firm-specific probability of default. A differencesin-differences analysis of firms' investment and risk taking in response to bankruptcy reforms that make debt more renegotiable confirms the cross-country evidence.