Bankruptcy law, creditors' rights and dividend policy: evidence from a quasi-natural experiment

Abstract

PurposeThe purpose of this paper is to examine how changes in creditors' rights affect the dividend policy behavior of corporate firms.Design/methodology/approachThe authors use the implementation of the bankruptcy and insolvency code (IBC) in India in 2016 as a quasi-natural experiment setup. Differential application of this law allows them to use the Difference in Differences approach to extract the marginal impact of change in creditors' rights on the dividend policy.FindingsThe authors show that firms responded to strengthening creditors' rights by decreasing their dividend payout. Further, the authors observe that this negative response is conditioned on firm leverage and the nature of the creditor, i.e. public or private. The firms with a greater leverage ratio and a greater proportion of private debt in the total debt in the pre-event period have shown greater response to the change in the law. Lastly, the authors show that stock markets positively respond to the observed decrease in dividends only when a corresponding decrease in the leverage accompanies such a decrease.Originality/valueThe authors contribute to the finance and law literature from several aspects. First, the authors extend this stream by bringing to light the dividend policy response of firms when they are subjected to a change in creditors' rights. Second, the authors also show how firm-level factors like financial policy and the nature of the creditor condition their response to IBC. Lastly, the authors also examine the market reaction to the dividend policy response of firms to the change in bankruptcy law.

Does an effective bankruptcy reform impact the selling cost behavior of firms? Evidence from India

“…Based on recommendations of this committee and suggestions received from the public, the GOI on February 28, 2015 categorically declared that "we will bring a comprehensive Bankruptcy Code in fiscal 2015-2016 that will meet global standards and provide necessary judicial capacity". Provided that, the ruling party had a vast majority in the parliament made it certain that the GOI was serious about implementing a new bankruptcy law in India (Jadiyappa & Kakani, 2023). Thus, it can be said that firms started to incorporate the possibility of stronger creditors' rights on account of a new bankruptcy law in their financial and operational decisions from the financial year 2015-2016 itself.…”

“…Prior to implementation of the IBC (pre‐IBC), multiple agencies such as the Debt Recovery Tribunals (DRTs), Board for Industrial and Financial Reconstruction (BIFR), and regular courts held “simultaneous jurisdiction over resolution of bankruptcy cases in India” (Jadiyappa & Kakani, 2023). This fostered an environment of inefficient and ineffective enforcement of creditors' rights.…”