kQPS 09?6 POLICY RESEARCH WORKING PAPER 28 65 Bankruptcy Around the World Explanations of its Relative Use Stijn Claessens Leora F. Klapper The World Bank Development Research Group U Finance July 2002 I Poi_ic RESEARCH WORKING I'AI'ER 2865 Abstract The recent literature on law and finance has drawn qualitV of the counltrics' overall uldicial systems on the attention to the importance of creditor rights in use of hankruptcV. influenicinig the developmlenit of financial systems and in The authors find, correctinig for overall financial affectinig firm corporate governance and financinig development anid macroeconiomic shocks, that patterns. Recent financial crises have also highliglhted the hankruptcies are highier in Anglo-Saxoni countries and in importanlce of insolvency systems to resolve corporate market-orienlted financial systems clharacterized by sector finanicial distress. The literature and crises have weaker and multiple banking relationships. They also emphasized the complex role of creditor rights, affectinig find that greater judicial efficiency is associated with not only the efficiency of ex-post resolution of distressed more LIse of bankruiptcy, buit that the combination of corporations, but also influencinig ex-antc risk-taking stronger creditor rights with greater judicial efficiency incenitives anid an economy's degree of entrepr-enieurship Ieads to less use. The authlors find that the presence of a more generally "stay on assets" leads to fewer bankruptcies indepenidelit Claessecis and Klapper docLliiment howv often of the efficiency of the judicial system. These findings bankruptcy is actUally heing used for a panel of 35 suggest that there are important incentive effects of counltries. Next they investigate the effects of specific insolvency systems encouraging less risky' behavior and designi featres of insolvency regimes in relatioii to the mor0e out-of-court settlemncits. This papcr-a product of Finance, Development Research Group-is part of a larger effort in the group to uliderstand corporate bankrtptcy. Copies of the paper are available free from the World lBank, 181 8 H Street NW, Washiligtoll, D.C. 20433. Please contact Agnes Yaptenco, room IvlC3-446, tclephone 202-473-1823. fax 202-522-1 155, eilail address ayaptenico(yt worldbanik.org. Policy Research Workiing Papers are also posted oii the Web at http://ccon.\worldbaa;k .org. -T-h atithors mav be contacted at sti jn0l fee.uva. nl or lklapper(iwvorldbank.org. July 2002. (34 pages). I'lhe P'olici Researclh W/orkiog Paper Series disseminates the tildings of work in progress tc encournrge the excbenzge of ideas abhot developmient issues. Ani object we of the series is to gLt the fiidinigs ont luicklY., even if the lpresentations are less than fi/vli polished. The papers carry the names of the au lthors and shouild be c-ited accordiPiivlv. The findinzgs, interpretations. and conclusions expr essed iii this paper are enitirelv those of the aiuthors. TheY do) not necessaril re present the vieu of the World Baink. its Executiite Directors, or tle counltries the' represenzt. Prodticed liv the Resea;rch Advisorv Staff Bankruptcy Around the World: Explanations of its Relative Use Stijn Claessens Finance Group University of Amsterdam Roetersstraat 11, 1018 WB Amsterdam, The Netherlands (31)-(20)-525-6020 stiin()fee.uva.nl Leora F. Klapper Development Research Group The World Bank 1818 H Street, NW Washington, DC 20433 (202) 473-8738 lklapper(.worldbank.org The authors would like to thank Sandeep Dahiya, Asli Demirguc-Kunt, Simeon Djankov, Fritz Foley, Roumeen Islam, Papillon Benoit Mario, David Skeel, and Do Quy-Toan for helpful comments and Jessica Lieberman and Victor Sulla for excellent research assistance. 1. Introduction The growing literature on law and finance, starting with the work by La Porta, Lopez de Silanes, Shleifer, and Vishny (1997, 1998), has drawn attention to the importance of the strength of equity and creditor rights in influencing the development of financial systems and in affecting firm corporate governance and financing patterns. This literature finds that greater investor protection encourages the development of capital markets and that countries that better protect creditors have more developed credit markets. Important aspects of the strength of creditor rights are the specific features of a country's insolvency regime and its enforcement. Recent financial crises have further highlighted the importance of well-functioning insolvency systems to prevent and resolve corporate sector financial distress. More generally, there is increased interest globally in the design of insolvency systems from a point of resource allocation, efficiency, and stability as well as equality and fairness (see Stiglitz 2001 and Hart 2000 for reviews). Insolvency regimes include a number of features, such as whether the law provides for an automatic trigger when a company needs to file for bankruptcy, who can file for reorganization or liquidation, the weight given to the debtor, the creditors (bank loans, trade financing), the company's management, and the other stakeholders in preparing reorganization proposals, the ability of management to stay during the reorganization, and whether an automatic stay of assets exists. In these design features, an insolvency regime tries to balance several objectives, including protecting the rights of creditors and other stakeholders - essential to the mobilization of capital for investment and working capital and other resources - and obviating the premature liquidation of viable firms. 2 A good insolvency regime should also prevent managers and shareholders from taking imprudent loans and lenders from giving loans with a high probability of default. At the same time, the insolvency regime should provide for a degree of entrepreneurship in the economy more generally. An insolvency regime should also deliver an ex-post efficient outcome, in the sense that the highest total value is obtained for the distressed firm with the least direct costs and loss in going concern value. The working of countries' judicial systems further complicates balancing these incentives. In addition to adequate legal rights, there is a need for an efficient judicial system to enforce these rights, or at least to serve as a credible threat. The analytical literature and recent crises have already highlighted the complex role of creditor rights in affecting not only the ex-post resolution of distressed corporations, but also in influencing ex-ante incentives and an economy's degree of entrepreneurship more generally. As the structure of economic production and the values of stakeholders are continuously changing - often in response to recent crises - many countries are also currently reevaluating the features of their creditor rights regimes and how their insolvency systems deal with financially distressed firms. This has proven to be a complicated area in many countries, with discussions on reform taking considerable time. Reforms may have been protracted in part because of the important implications of any changes for the distribution of wealth and control in an economy, raising in turn complex political economy issues. Reforms may have also been hampered by the lack of empirical evidence across countries on the effects of bankruptcy use and efficiency. 3 While more data are being collected on differences in bankruptcy regimes across countries,' to date little is known on the effects of specific creditor right features and their interaction with the judicial system and other country characteristics. The cross-country empirical evidence has largely been limited to the general effects of creditor rights. Even here the evidence has been mixed, with some finding only limited or no significance of the aggregate strength of creditor rights on financial development. Furthermore, the precise channels through which a country's institutional inheritance affects its financial development and what aspects of legal systems are most important for firm financing are still being investigated. Much research is being conducted, for example, on what aspects of a Common (Civil) Law heritage help explain that such countries have more (less) developed equity and financial markets. More robust tests and indirect measures are being used to explore the channels through which countries' legal and institutional "structure" matter.2 One indirect measure that may help shed light on these channels might be the actual use of bankruptcy as a means to resolve financial distress and the relationship between actual use and a country's institutional features, including its creditor rights, legal heritage and judicial system. To date, however, it is not known how often bankruptcy is actually being used in countries around the world. Neither is it known why its usage varies by country characteristics like differences in legal systems, accounting l The World Bank, Asian Development Bank, and Inter-American Development Bank have started to document the detailed features of bankruptcy systems in many countries. The World Bank has also undertaken a review of desirable principles and guidelines for bankruptcy systems. 2 See Acemoglu, Johnson and Robinson, 2001, Beck, Levine and Loayza, 2000, Berglof and Von Thadden, 1999, Coffee, 2000, La Porta et al., 2002, Rajan and Zingales, 1999 and 2002, and Stulz and Williamson, 2001. 4 standards and regulatory frameworks, as well as differences in the development of financial and capital markets and macroeconomic conditions. The purpose of this paper is to explore the relative importance of country characteristics and the effect of different types of creditor rights that can help explain the relative use of bankruptcy. For this, we collect from various government and private sources a unique dataset of the number of commercial bankruptcy filings in 35 countries. As shown in Appendix 2, almost all countries in our sample have laws protecting secured creditor rights and have bankruptcy laws permitting both liquidation and restructuring of distressed firms. There is considerable variation, however, in how frequently these laws are resorted to through formal bankruptcy filings. The data on actual bankruptcies allows us to investigate which legal design features and macro, financial, and other country characteristics affect the likelihood that creditors use formal bankruptcy procedures as a means of resolving corporate financial distress. To our knowledge, this paper is the first attempt to identify empirically reasons for the use of bankruptcy across countries. We find, correcting for overall financial development and macroeconomic shocks, that bankruptcies are higher in common-law countries and in market-oriented financial systems. We also find that greater judicial efficiency is associated with more use of bankruptcy, but that the combination of stronger creditor rights - both aggregated and evaluated separately by specific features - and greater judicial efficiency leads to less use of bankruptcy. Interestingly, we find that the presence of a "stay on assets" leads to fewer bankruptcies independently of the efficiency of the judicial system. These findings suggest that there are important ex-ante incentive effects of insolvency systems, including encouraging less risky behavior and more out-of-court settlements. But our 5 findings also suggest that efficient legal mechanisms themselves may help corporations achieve speedy resolutions of financial distress. In tum, these finding may shed light on the debate of what are the precise channels through which a country's institutional structure affects its financial development. 2. Previous Literature and Hypotheses The central role played by law and regulatory institutions in the development of financial markets in general and in corporate finance in particular has received considerable attention in recent years. La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1998) examine cross-country differences in the quality of laws, regulations, and enforcement, including creditor rights. They document considerable variation in the protection offered to creditors and minority shareholders across countries. They also find a significant association between the legal origins of a country and the quality of investor protection. In particular, their findings show that common law countries (Anglo-Saxon) generally provide the best investor protection whereas civil law origin (French, German, and Scandinavian) countries provide the least investor protection. Importantly, the literature on law and finance has drawn attention to the importance of equity and creditor rights in influencing the development of financial systems and in affecting firm corporate governance, ownership, and financing patterns. A number of papers have reported significant relationships between the legal framework of a country and its financial development and economic growth and between investor 6 protection and legal origin and various corporate governance issues, such as firm dividend payout policies, firm valuation, and corporate ownership structures.3 To investigate these relationships in the case of creditor rights, La Porta et al. (1998) created an index of CREDITOR RIGHTS consisting of the summation of four dummy variables, with four the highest possible score. The dummy variables they report are: TIME, equal to 1 if the timetable for rendering a judgment is less than 90 days, and 0 otherwise; MANAGER, equal to 1 if incumbent management does not stay during a restructuring or bankruptcy, and 0 otherwise; STAY, equal to 1 if there is no automatic stay on assets, and 0 otherwise; CREDITOR, equal to 1 if secured creditors have the highest priority in payment, and 0 otherwise. La Porta et al. (1997) reports a positive relationship between the ratio of domestic debt to GDP and this aggregate creditor right index, although the creditor rights variable has only 10% significance. Controlling for the country's legal origin (Anglo-Saxon, French, Germanic, and Scandinavian) and the existence of the rule of law in the country, the significance of the creditor rights variable actually disappears. Neither La Porta et al. (1997) nor the other papers on law and finance investigated the effects of each specific sub-index of the Creditor Rights index on the development of the credit markets. We may expect, however, that there are considerable differences between the effects of each specific creditor rights on firm and creditor behavior. A stipulation in the insolvency law that provides creditors with the right of no automatic stay on assets, for example, provides creditors with some bargaining power that may 3See Beck, Levine and Loayza, 2000, La Porta et al., 1997 and 2002, Rajan and Zingales, 1995 and 1998, La Porta, Lopez-de-Silanes, and Shleifer, 1999, and Demirgiiu-Kunt and Maksimovic, 1998. 7 allow them to more easily negotiate debt restructuring out of court. At the same time, the absence of an automatic stay may lead to a creditor race to seize assets, thus possibly accelerating the possibility of financial distress and bankruptcy. Interestingly, work at the global level on developing principles and guidelines for an effective insolvency and creditor right system suggests that there should preferably be an automatic stay on assets for at least some initial period (World Bank, 2001). This differs from La Porta et al. (1998) whom consider in constructing their index the absence of an automatic stay a positive creditor rights feature. This suggests that there are some differences of opinion on what constitute desirable creditor rights features, which in turn may relate to our lack of understanding on how certain creditor rights features affect actual bankruptcy use. The presence in the law of secured creditor priority and absolute priority of claims in bankruptcy or restructuring (i.e., senior creditors are paid first, then junior creditors, followed finally by shareholders if any residual remains) is another example. Such priority may deter ex-ante risky financial behavior and thus reduce the likelihood of financial distress. Such feature can also help overcome creditor coordination problems when a corporation is in restructuring. At the same time, if the law stipulates that shareholders receive nothing in bankruptcy, a firm may attempt to delay or avoid bankruptcy, including undertaking more high-risk projects when the corporation starts to run into financial distress. Depending on whether the insolvency law at the same time stipulates whether managers have to automatically leave when a firm is in bankruptcy, incentives will vary whether managers will act or not on behalf of shareholders. These discussions show that each of the specific creditor right features may influence firm and creditor behavior differently and what constitutes a desirable creditor 8 right feature may depend on circumstances or objectives.4 While we may expect the use of bankruptcy to vary with the strength of (specific) creditor rights, this will also be influenced by the ability of creditors to use these rights, which in turn will depend on the efficiency of the judicial system. Modigliani and Perotti (2000) draw attention to the finding that when a country's enforcement regime is unreliable, transactions may be carried out through some form of private enforcement. La Porta et al. (1997) show the importance of the judicial system, in addition to formal legal rights, for financial market development. Berkowitz, Pistor and Richard (2000) argue that the quality of laws, as often measured by the country's legal origin, is only a crude proxy for the effectiveness of legal systems - instead it is the effective enforcement of laws rather than the quality of laws that matters.5 Whether courts are asked to help resolve financial distress may also similarly depend on the efficiency of the judicial systems. Creditors may be more likely to undertake the costs of filing for bankruptcy if they are able to effectively use the courts in the case of default. A country with strong and efficient legal enforcement might thus see more frequent use of the statutory provisions provided in the legal code. At the same time, if enforcement is strong, we may expect debtors and creditors to try to avoid risky 4 Furthermore, while the work by La Porta et al. (1998) provides some detail on creditor right features, obviously there are many other aspects in which insolvency regimes differ across countries. The work at the World Bank on developing Principles and Guidelines for Effective Insolvency and Creditor Rights Systems mentions, for example, 35 principles countries could adopt or pursue. The effects of these more detailed design features may in turn be reflected in the relative use of bankruptcy across countries. Unfortunately, data on more detailed features are not available in a systematic way. 5 For transition economies, Pistor, Raiser and Gelfer (2000) show that the laws on the books have limited effects on financial market development, but that measures of effective enforcement do. Rajan and Zingales (1999 and 2002) also provide evidence that argues for factors other than legal origin as predictors of stock market growth. 9 behavior, thereby reducing the chances of financial distress and bankruptcy. Alternatively, if enforcement is weak, debtors and creditor may try to work out a situation of financial distress through private negotiations, since the transaction costs of using an inefficient enforcement system may be too high. At the same time, in countries with weak judicial systems, debtors may engage in more risky financial behavior, thus leading to more financial distress. Corporate financial distress provides one specific setting to examine the effects of the efficiency of the judicial system relative to the formal laws. For example, Claessens, Djankov, and Klapper (2002) found that in a sample of East Asian countries, creditors are more likely to incur the costs of bankruptcy if ex-ante creditor rights and ex-post judicial efficiency indicate a likely recovery of losses. This suggests that variations in enforcement efficiency should cause differences in the use of formal bankruptcy procedures, even if bankruptcy laws are broadly similar. The impact of the (lack of) judicial efficiency may also vary by specific creditor right as the need for enforcement varies. The absence of an automatic stay on assets may, for example, be very valuable to creditors when the judicial system is weak as it can force debtors to negotiate out of court. But in a strong judicial system, the absence of a stay may be more beneficial as it preserves the going concern value of firms in reorganization, thereby reducing the chances of eventual bankruptcies. More generally, the features of an insolvency system are designed to deal with specific issues, such as too risky behavior by debtors, creditor races to grab assets, the preservation of going concern value, the maintenance of priorities among claims to preserve incentives for monitoring, etc. The 10 degree to which the effectiveness of a specific feature depends on the judicial system and its consequent relationship with actual bankruptcy use is likely to differ. In addition to exploring the relationship between the use of bankruptcy and the features of creditor right regimes, we also want to investigate the relative role of bank- oriented versus market-oriented financial systems. As discussed by Allen and Gale (1997), Levine (1999), and Demirguc-Kunt and Levine (1999), countries differ in the structure of their financial system. The relation of the orientation of the financial system with the use of bankruptcy is unclear, however. In bank-oriented economies, firms often depend on a single, powerful banking relationship as a primary source of all forms of extemal finance, which may include both debt and equity financing. In market-oriented economies, firms often have multiple bank lenders and widely held publicly traded equity. We would expect that the arms-length banking relationships found in market- oriented systems present more incentive for creditors to use formal bankruptcy measures to coordinate among creditors. As shown in Gilson, John, and Lang (1990), firms in the United States that use in-court bankruptcy proceedings have a smaller percentage of debt owed to banks and a greater number of lenders. This suggests that creditors in market-based economies may benefit more from those aspects of bankruptcy law that aim to overcome collective action problems among creditors. Also, firms in bank-oriented economies tend to have closer relationships with their primary bank and the bank may also have an equity investment in the firm. Creditors in bank-oriented economies may therefore have less need or be less inclined to use formal (and costly) bankruptcy filings to resolve financial distress. Evidence for Japan and Germany indeed suggests that borrowers' main banks not only help avoid 11 costly financial distress, but also act as coordinator of financial support and restructuring in times of financial distress. On the other hand, since firms in bank-oriented economies have typically greater percentages of bank debt, we might expect higher leverage to lead to a higher number of bankruptcies in bank-oriented systems. Also, in bank-based systems there may be more scope for conflicts of interest between the role of banks as creditor and as equityholder. More generally, a bank-oriented system may have more scope for perverse relationships between financial institutions and corporations. For example, Claessens, Djankov, and Klapper (2002) show that firms in East Asia with a bank as their controlling shareholder are less likely to use bankruptcy as a means of resolving financial distress. Furthernore, we want to test whether countries with more significant new business entry restrictions have fewer bankruptcy filings. The lack of entry would make for a less competitive industry, which in turn could imply fewer exits, as discussed extensively in the industrial organization literature (i.e., Hopenhayn, 1992).6 In previous literature, Dunne, Roberts, and Samuelson (1988) find that entry and exit rates within industries are highly correlated - industries with higher than average entry rates tend to also have higher than average exit rates. We also want to explore the relationship of the distribution of firm size with the occurrence of bankruptcy. On one hand, a larger share of small firms may reduce the number of bankruptcy relative to the total number of fimns, as small firms are less likely to incur the cost of a formal bankruptcy procedure. On the other hand, small firms may be more risky and consequently a large share of small firms in an economy may raise the relative number of bankruptcies. In addition to these 6 For a review of the literature see Caves (1998). 12 variables, we also expect that the general development of the country, the occurrence of a systemic banking crisis, and the level of economic growth will affect the relative use of bankruptcy. 3. Data and Summary Statistics The number of total commercial bankruptcy filings was collected from government and private sources around the world for all available years between 1990- 1999.7 We include the sum of all firms that file for liquidation or reorganization under the bankruptcy code. This measures the total use of the bankruptcy law and the judicial system to resolve corporate financial distress. In order to compare the relative use of bankruptcy cross-country, we normalize the number of bankruptcy filings. We use the total number of firms, as provided by Djankov, La Porta, Lopez-de-Silanes, and Shleifer (2002) and official country statistical handbooks.8 Tables 1 and 2 show some summary statistics for the countries in our sample panel. To explain the relative use of bankruptcy, we include as explanatory variables measures of macroeconomic performance, financial structure, efficiency of judicial system, other institutional measures, and the specific creditor rights discussed above. We expect that the number of failed firms depends on a country's current and expected 7 See Appendix 1 for the country sources. In part because, there is variation across countries in the definition and implications of bankruptcy, we include all legal proceedings designed to either liquidate or rehabilitate an insolvent firm. Results were qualitatively robust to analyzing only liquidation procedures for those countries that identified those numbers separately. 8 For seven countries, only the total number of manufacturing firms is available. For these countries we extrapolate the total number of firms by sector and legal origin (English, French, etc.). All empirical results are robust to the exclusion of these countries. 13 economic performance, as measured by the performance and growth of GDP. We therefore include lagged real GDP per capita in US$, RGDPPCt ., and the lagged 1-year growth rate of real GDP, GDPGt.1.9 We expect countries experiencing negative growth to have higher rates of defaults. We also control for periods of systemic banking crises with data from Caprio and Klingebiel (2000), D_CRISISt.1, which may indicate periods of not only economic slowdown but also periods during which borrowers are more constrained in finding additional bank financing and more likely to file for bankruptcy. We also include lagged real interest rates as a measure of the cost of financing, RINTERESTt.1, expecting to find that higher real interest rates are associated with more defaults. To measure the relative orientation of banks versus equity markets, we include a dummy variable provided by Demirguc-Kunt and Levine (1999), D_BNKORIENT, that identifies countries as market- versus bank-oriented, depending on the relative importance of intermediated (bank) versus direct (capital) financial markets. To test whether countries with more significant entry restrictions have fewer bankruptcy filings, we use the data collected in Djankov, La Porta, Lopez-de-Silanes, and Shleifer (2002) on the restrictiveness of entry-the time to establish a new business-to test whether entry and exit rates tend to be correlated across countries. This variable is called TIME. We also test for the effect of a higher concentration of SMEs, measured as the percentage of employment attributed to SMEs collected by Klapper and Sulla (2002) and denoted here by SME_SHARE. 9 The subscript, t, indicates a time series. All other variables are constant over time, but vary by country. 14 We include dummies to indicate legal origins - FRENCH, ENGLISH, GERMAN, SCANDINAVIAN, and TRANSITION. These origins proxy broadly for creditor rights, with English, common law countries being regarded as more creditor- friendly, whereas French, civil law countries are regarded as more debtor-friendly. However, these variables also capture other aspects, including the adaptability of the legal system and elements of the efficiency of the legal system. In addition to including legal origins, which are exogenously determined, we expect the implementation of laws to be a significant factor and therefore also include an index of the efficiency and integrity of the legal environment, RULE of LAW, as reported for most countries by La Porta et al. (1998) and for transition economies by Pistor (2000). As an alternative measure regarding the efficiency of the judicial system, we use a "legality" index, which is the weighted average of indexes provided by Business International Corporation of the Efficiency of the Judiciary, Rule of Law, Corruption, Risk of Expropriation, and Risk of Contract Repudiation (Berkowitz, et al., 2002).Io Finally, we use the La Porta et al. (1998) index of CREDITOR RIGHTS, consisting of the summation of four dummy variables, RESTRICTIVE REORGANIZATION, NO AUTOMATIC STAY ON ASSETS, SECURED CREDITOR PRIORITY, and MANAGEMENT DOESN'T STAY, with a highest possible score of four." l We also use the individual sub-indexes. ° This index is unavailable for transition economies. l Almost all countries have formal liquidation and reorganization laws (see Appendix 2). 15 4. Empirical Results We set up the regressions as a panel of country and years. Since we do not have the same number of years in which we have observation on bankruptcy rates for each country (Table 2), we have an unbalanced panel of 273 observations. Our first regression results are shown in Table 3. The specification used always includes the level of GDP per capita, lagged GDP growth rate, a dummy for whether the country experienced a systemic financial crisis during the period, and the real interest rate. Column (1) shows the base regression results. We find that countries with higher levels of real GDP per capita have higher uses of bankruptcy. This suggests that greater overall development is consistent with greater judicial efficiency and more court usage. Lagged GDP growth rate has the expected negative sign, and is statistically significant at the 10% level. The systemic crisis dummy has the expected positive sign, but is not statistically significant. The real interest variable has a positive sign as well, but is also not statistically significant. The next regression, Column 2, includes the market orientation variable. The significantly positive coefficient on D_MKTORIENT shows that bankruptcy use is greater in countries with more use of market financing and less in bank-based systems. This supports our hypothesis that countries in which banks have closer relationships with borrowing firms have less dispersed creditors and thus less need for court-driven coordination among creditors, and are less likely to use bankruptcy to resolve financial distress. Table 3, Column 4, shows the effect of the ease of new business entry on the use of bankruptcy. We find a significantly positive relationship between the time required to 16 operate a new business and the use of bankruptcy - countries in which it is more restrictive and difficult to open a new business also have lower rates of bankruptcy. One explanation is that both procedures - registering a new business and filing for bankruptcy - are dependent on an efficient public sector, including an efficient judicial system. This seems not generally the case, however. Germany, for example, which has a high index of judicial efficacy, requires a relatively long time to start a new business, 90 working days, and has a relatively low average bankruptcy rate of 1.03% over the period. In contrast, Canada, which also has a high level of judicial efficiency, requires only 2 days to start a new business and has a relatively high average bankruptcy rate of 2.96%. The significant relationship may rather mean that countries that allow easy business entry permit a more natural "learning-curve", during which relatively more firms are expected to fail, while countries that require, for example, more documentation of qualifications and financial backing, may have lower rates of business defaults. Another, complementary explanation is that countries which restrict competition through entry also assure the profitability and allow the survival of less efficient firms, thus keeping the overall bankruptcy rate low. In Column 5 we include the share in total employment by small and medium sized enterprises (SMEs). This variable is collected from a variety of sources over a number of years and as such is perhaps not as robust an indicator of the importance of small firms to the economy. It is, however, very significantly negative, suggesting that the SMEs are less likely to use bankruptcy courts. This may be because of the high fixed costs involved in using legal proceedings and courts, which makes using formal bankruptcy less efficient for SMEs. Furthermore, SMEs may rely more on a smaller 17 number of creditors, making out of court negotiations more likely. Also, SNIE failures may more likely reflect "economic" distress, which suggests that SMEs that fail have less need for bankruptcy procedures to preserve going concern value through formal distribution of firm assets. 12 Finally, in Column 5 we introduce individual country-dummies and we find that the significance of some of the variables changes. In particular, the level of GDP per capita and the lagged output growth rates are not longer statistically significant, which can be expected as the country dummies control for much of each country's overall macroeconomic environment. The systemic crisis dummy becomes statistically significant, however, while the real interest rate keeps its positive, but still insignificant sign. We next introduce the legal variables for our complete sample. We start with the relationship between legal origins and bankruptcy rates. Table 4, Column (1) shows that countries with French and German civil law codes - which are typically categorized as having weaker creditor rights - use bankruptcies significantly less than countries in the common law orientations.13 In addition, we find that transition countries have lower use of bankruptcy, perhaps because their legal codes and judicial systems are newer and because creditors and borrowers have less experience using the courts to resolve distress. Column (2) includes the index of rule of law, which proxies for the efficiency of the legal environment. We find this measure to be significantly positively related to the 12 This result may also be partially explained by the high correlation between the size of the SME sector and legal origins as shown in Klapper and Sulla (2002). 13 The exception is Scandinavia, which has significantly higher bankruptcies than English countries, although this may be a result of Scandinavia's recent banking crisis and the fact that all Scandinavian countries are high-income. 18 occurrence of bankruptcy - the greater the likelihood of a creditor speedily and successfully collecting in the court, the more likely creditors are to use formal and costly bankruptcy proceedings in the case of default. When we include both legal origin and rule of law, Column (3), we find that both are statistically significant, but that the coefficient for the rule of law variable loses some of its significance. This can probably be explained by the correlation between the legal family of a country and the efficiency of its legal system (as already noted by La Porta et al. (1998)).14 Next we study the importance of the overall strength of creditor rights by including the index CREDITOR RIGHTS in the regression in Column 4. Interestingly, the overall strength of creditor rights is not statistically significant related to the occurrence of bankruptcy across countries. An argument could be made that on one hand stronger rights deter bankruptcy - as debtors and creditors both avoid risky financing patterns and prefer to negotiate out of court in times of financial distress.15 On the other hand, stronger rights allow bankruptcy procedures to be used more effectively. The net effect may be that the aggregate creditor rights are not statistically significantly related to the occurrence of bankruptcy. When we also include the degree of judicial efficiency in Column 5, we find that the coefficient for creditor rights remains statistically insignificant. This provides some support for the hypothesis that the overall strength of creditor rights has two offsetting effects: the deterrence part, with a negative relationship 14 As a robustness check, we substitute the rule of law index with the legality index for all regressions and we find that our results remain equally significant. However, for these regressions we cannot include the transition countries as the rule of law index is not available. 15 However, often, even in the US, when parties reach an agreement outside of court they frequently formally file for bankruptcy to avoid future contract disputes. 19 with bankruptcy use, and the actual usage part, with a positive relationship with bankruptcy use. The latter relationship is picked up in part in this regression by the efficiency of the legal system, making the coefficient for creditor rights more negative. Thus far our interpretation is based on an analysis of the strength of aggregate creditor rights, and not yet its individual components. As discussed before, each of the four separate creditor rights may have a different effect on the occurrence of bankruptcy, which may explain why we did not find a statistically significant effect of the aggregate creditor rights index on bankruptcy use. We therefore next analyze the relationship between the four separate indexes and the occurrence of bankruptcy, with regression results reported in Table 5.16 Of the four subindexes, one is statistically significantly positive - RESTRICTIVE REORGANIZATION in Column 1 - and one is statistically significant negative - NO AUTOMATIC STAY ON ASSETS, in Column 2. The other two subindexes are not statistically significant. This suggests that the deterrence and actual usage effects vary by creditor rights. The presence of restrictions for going into reorganization, such as creditors' consent, seems to provide creditors with more legal tools and lead to more bankruptcy. The ability of secured creditor to seize assets even when a firm has filed for reorganization (no automatic stay), in contrast, seems to deter bankruptcy. This suggests that the presence of an automatic stays aimed at avoiding creditor races strengthens the overall leverage of creditors. It is interesting that priority of secured creditors is not significant. This may indicate that a priority creditor rights feature deters risky behavior and thus reduces the probability of bankruptcy. It may also 16 These regressions exclude transition economies since data on the subindices of creditor rights is unavailable. As a result, the number of observations drops from 273 to 252. 20 be that laws permitting secured creditors rights are less important than having a business environment that allows, for example, easy registering of collateral and the presence of courts which speedily enforce secured claims (before the creditor can liquidate the asset). Note that in these regressions we control for the effects of the judicial efficiency on the likelihood of bankruptcy by including our legality variable that has consistently a positive relationship with the number of bankruptcies. To further test the interaction between the effects of judicial efficiency and the individual and aggregate creditor rights, we run a set of regressions where we include, in addition to the creditor rights (sub-) indexes and the judicial efficiency index, also the interaction between the two indexes. As shown in Table 6, we find that the coefficients for the interaction variables between the aggregate creditor rights index and most of the creditor rights subindexes have statistically significant negative signs, with the exception of NO AUTOMATIC STAY ON ASSETS, which is significantly positive. At the same time, the creditor rights index and the subindexes themselves are mostly statistically significantly positive.'7 This suggests that in countries with high judicial efficiency the credible threat of speedy action by the courts combined with strong creditor rights deters risky behavior and encourages out-of-court negotiations. However, speedy action by the courts in itself leads to more usage of bankruptcy, as does the presence of stronger creditor rights. This in turn suggests that in countries with weak judicial proceedings creditors will use bankruptcy - a costly resolution - only if they have strong entitlements. In others words, in weak judicial settings rights may have to be stronger to compensate for inefficiencies in the courts. 7 The only exception is that of the NO AUTOMATIC STAY ON ASSETS index. 21 5. Conclusion In this paper we report the relative number of commercial bankruptcy filings in 35 countries. We use this data to investigate which legal, financial and other country characteristics affect the likelihood that a formal bankruptcy procedure is used. We find, correcting for overall development and macroeconomic shocks, that market-oriented economies are more likely to use bankruptcy than bank-oriented economies. This may be attributed to the weaker banking relationships and the stronger need for a legal framework to assist with coordination among creditors. We also find that countries with more efficient and speedy procedures to open a new business have greater bankruptcy use. This may reflect not only an overall more effective legal and regulatory process, but also that firm entry and exit rates are related. And we find that the presence of more small and medium firms is associated with less usage of bankruptcy, which may reflect the costs of using formal bankruptcy procedures deterring use by smaller firms. We find that bankruptcies are higher in Anglo-Saxon countries, but that stronger creditor rights alone are not associated with more use of bankruptcy. There are important differences in these effects by individual creditor rights, however, and we find that the presence of a "no automatic stay on assets" is associated with fewer bankruptcies and the presence in the law of a "restriction on reorganizations" with more bankruptcies. These results are also not independent of the efficiency of the judicial system. We find that greater judicial efficiency is associated with more use of bankruptcy, but that the combination of stronger creditor rights with greater judicial efficiency leads to less use. These findings suggest that there are important incentive effects of insolvency systems combined with good judicial systems encouraging less risky behavior and more out-of- 22 court settlements. They also suggest that in countries with weak judicial proceedings, strong creditor rights are more necessary to compensate for weaknesses in legal enforcement. 23 References: Acemoglu, Daron, Simon Johnson, and James A. Robinson, 2001, The colonial origins of comparative development: an empirical investigation, American Economic Review 91, 1369-1401. Allen, Franklin and Douglas Gale, 2000. Optimal Financial Crises, Journal of Finance, Berkowitz, Daniel, Katharina Pistor and Jen-Francois Richard, 2002, Economic Development, Legality, and the Transplant Effect, Forthcoming in the European Economic Review. Beck, Thorsten, Ross Levine, and Norman Loayza, 2000, Finance and the sources of growth, Journal of Financial Economics 58, 261-300. Berglof, Erik and Ernst Ludwig Von Thadden, "The Changing Corporate Governance Paradigm: Implications for Transition and Developing Countries", Working Paper, June 1999 Coffee, John, 2000, Convergence and its Critics: What are the Preconditions to the Separation of Ownership and Control, mimeo, Columbia University. Caprio, Gerard and Daniela Klingebiel, 2002. Episodes of Systemic and Borderline Financial Crisis, in D. Klingebiel and L. Laeven (ed.), Managing the Real and Fiscal Effects of Banking Crises, Discussion Paper No. 428, Washington: World Bank. Caves, Richard, 1998. Industrial Organization and New Findings on the Turnover and Mobility of Firms, Journal of Economic Literature, v36, n4, December, 1947-82. Claessens, Stijn, Simeon Djankov, and Leora Klapper, 2002. Resolution of Corporate Distress in East Asia, forthcoming, Journal of Empirical Finance Demirguc-Kunt, Asli and Ross Levine, 1999. Bank-Based and Market-Based Financial Systems: Cross-Country Comparisons, World Bank working paper. Demirguc-Kunt, Asli and V. Maksimovic, 1998. Law, Finance, and Firm Growth, Journal of Finance, 53(6), 559-588. Djankov, Simeon, Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer, 2002. The Regulation of Entry, Quarterly Journal of Economics Dunne, Timothy, Mark Roberts, and Larry Samuelson, 1988. Patterns of Firm Entry and Exit in US Manufacturing Industries, Rand Journal of Economics, v19, Winter, 495-515. 24 Gilson, Stuart, Kose John, and Larry Lang, 1990, Troubled Debt Restructurings: An Empirical Study of Private Reorganization of Firms in Defaults, Journal of Financial Economics, 27, 2: 315-353. Hart, Oliver, 2000, Different Approaches to Bankruptcy, National Bureau of Economic Research, Working paper 7921, Cambridge, Massachusetts, September. King, Robert, and Ross Levine, 1993. Finance, Entrepreneurship, and Growth: Theory and Evidence, Journal of Monetary Economics, 32(3), 513-542. Klapper, Leora and Victor Sulla, 2002, SMEs Around the World: Where Do They Matter Most?, World Bank working paper. La Porta, Rafael, Florencio Lopez-de-Silanes, and Andrei Shleifer, 1999. Ownership Structures Around the World, Journal of Finance, December, Volume 54. No. 2, 471-517. La Porta, Rafael, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert W. Vishny, 1997. Legal Determinants of External Finance, Journal of Finance 52: 1131- 1150. , 1998. Law and Finance, Journal of Political Economy: 106: 1113-55, December. , 2002, Investor Protection and Corporate Valuation, Journal of Finance, Volume 57. No. 3, 1147-1170. Laughran, Timothy, Jay Ritter, and Kristian Rydqvist, 1994. Initial Public Offerings: International Insights, Pacific Basin Finance Journal, 2, 165-199. Levine, Ross, 1999. Law, Finance, and Economic Growth, Journal of Financial Intermediation, January, 17-57. Modigliani, Franco and Enrico Perotti, 2000. Security Markets versus Bank Finance: Legal Enforcement and Investor Protection, International Review of Finance, vol I no 2, p. 81-96, 2000. Pistor, Katharina, 2000, Patterns of Legal Change: Shareholder and Creditor Rights in Transition Economies, The European Business Organisation Law Review Vol. 1 Nr. 1, 59-108. Rajan, Raghuram and Luigi Zingales, 1995. What Do We Know about Capital Structure? Some Evidence from International Data, Journal of Finance, December, 1421- 1460. , 1998, Financial dependence and growth, American Economic Review 88, 559-586. 25 , 1999, "The Politics of Financial Development", mimeo, University of Chicago. , 2002, The Great Reversals: The Politics of Financial Development in the 20 Century, mimeo, University of Chicago. Stiglitz, Joseph, 2001, Bankruptcy Laws: Some Basic Economic Principles. In Resolution of Financial Distress (Stijn Claessens, Simeon Djankov, and Ashoka Mody, eds.), World Bank Institute, Washington, D.C., pp. 1-23. Stulz, Rene and Ronald Williamson, 2001, "Culture, Openness, and Finance", NBER working paper 8222. World Bank, 2001, April Draft Principles and Guidelines for Effective Insolvency and Creditor Rights Systems, available at www.worldbank.org/legal. 26 Table 1: Summary Statistics, by Countrv Number of Bankruptcies was collected from sources listed in Appendix 1. BNKRPT_FRM is the ratio of the number of bankruptcies to the number of firms. Real GDP per capita in US$ (RGDPPC), I-year growth rates of GDP (GGDP), and real interest rates (RINTEREST) are from the International Financial Statistics. Statistics are reported as the average over the period of available years. Available Number of BNKRPT_ RGDPPC GGDP RINTEREST Country Years Bankruptcies FRM (%) (US$, 1995) (%) (%) ARGENTINA 92-99 2144.38 0.12 7,567.47 6.37 4.26 AUSTRALLA 90-99 5166.50 2.10 21,120.16 4.47 8.50 A USTRIA 90-99 2065.10 1.33 28,774.78 2.58 3.73 BELGIUM 90-99 4850.20 2.59 26,784.65 2.10 3.32 CANADA 90-98 12696.67 2.96 19,280.07 1.93 6.29 CHILE 90-99 88.60 0.28 4,195.95 7.66 13.22 COLOMBIA 96-99 225.50 0.16 2,411.81 2.81 19.99 CZECH REP UBLIC 92-96 1729.40 1.49 4,755.23 -0.78 -2.33 DENMARK 90-99 2375.90 1.53 33,582.58 1.93 7.77 FINLAND 90-98 5106.11 4.14 25,587.28 1.39 6.34 FRANCE 90-99 51671.75 2.62 26,293.72 1.65 6.64 GERMANY 92-98 21152.57 1.03 29,782.87 1.46 8.43 GREECE 90-94 857.4 0.29 10,987.33 1.20 9.18 HONG KONG 90-98 1205.44 0.55 22,610.76 4.98 2.33 HUNGARY 92-96 8425.40 1.99 4,252.39 -2.22 4.74 IRELAND 90-99 788.60 2.74 17,580.34 6.47 5.23 ITALY 90-96 8663.14 0.54 18,431.58 1.61 7.64 JAPAN 90-99 14000.60 0.22 41,709.64 2.18 3.61 NETHERLANDS 90-99 4154.56 1.30 9,780.62 5.75 3.29 NEW ZEALAND 93-98 716.00 3.67 27,106.94 3.44 5.63 NORWAY 90-98 3546.56 1.83 15,981.80 3.54 9.42 PERU 93-99 145.14 0.05 31,786.32 3.44 8.02 POLAND 90-96 3319.57 0.23 2,180.54 4.92 26.87 PORTUGAL 91-99 516.44 0.08 2,984.64 0.99 -5.34 RUSSIA 95-98 2770.75 0.31 10,791.99 2.73 7.95 SINGAPORE 90-99 227.80 3.06 2,274.35 -4.80 51.49 SOUTHAFRICA 90-99 2918.60 4.62 21,414.20 8.06 4.03 SOUTH KOREA 90-98 162.67 0.17 3,944.43 1.38 6.54 SPAIN 90-99 518.60 0.02 14,764.81 2.59 5.91 SWEDEN 90-99 13917.10 7.61 27,088.16 1.36 7.57 SWITZERLAND 90-98 9212.56 3.33 44,345.91 1.08 3.71 THAILAND 90-99 346.73 0.12 2,480.25 6.03 7.34 TURKEY 98-99 1496.00 0.86 3,149.98 5.31 -5.44 UNITED KINGDOM 923-98 46583.83 1.85 18,942.57 2.61 3.75 UNITED STA TES 90-99 55752.60 3.65 27,344.91 2.97 5.56 27 Table 2: Summary Statistics, by Country D_MKTORIENT is a dummy equal to 1 if the country is market-oriented and equal to 0 if the country is bank-oriented (Demirguc-Kunt and Levine, 1999). TIME is the number of business days required for a business to become operational (Djankov et al., 2000). SME_SHARE is the percentage of total employment in the SME sector (Kiapper and Sulla, 2002.) RULE OF LA W is an index of legal and judicial efficiency (La Porta, et al., 1998 and Pistor, 2000.) CREDITOR RIGHTS is an index from I to 4 (La Porta, et al., 1998 and Pistor, 2000.) Counry MITORENTTU%E SM SARE LEGAL RULE CREDITOR Country D _MKTORIENT| TIME S ME_SHARE ORIGINS OF LAW RIGHTS ARGENTINA 0 71 70 French 5.35 1 AUSTRALIA 1 3 40 English 10 I AUSTRIA 0 154 57 German 10 3 BELGIUM 0 42 55 French 10 2 CANADA 1 2 56 English 10 1 CHILE 1 78 90 French 7.02 2 COLOMBIA 0 N/A 67 French 2.08 0 CZECH REPUBLIC 0 97 65 Transition 8.3 3 DENMARK 1 21 70 Scandinavian 10 3 FINLAND 0 32 45 Scandinavian 10 1 FRANCE 0 53 64 French 8.98 0 GERMANY 0 90 76 German 9.23 3 GREECE 0 53 74 French 6.18 1 HONG KONG 1 41 60 French 8.22 4 HUNGARY 0 53 64 Transition 8.7 3.75 IRELAND 0 25 50 English 7.8 1 ITALY 0 121 73 French 8.33 2 JAPAN 0 50 78 German 8.98 2 NETHERLANDS 1 68 60 French 10 2 NEW ZEALAND 0 17 54 English 10 3 NORWAY 0 24 54 Scandinavian 10 2 PERU 1 171 68 French 2.5 0 POLAND 0 26 75 Transition 8.7 2.25 PORTUGAL 0 99 70 French 8.68 1 RUSSIA 0 N/A 10 Transition 3.7 3 SINGAPORE I 36 N/A English 8.57 4 SOUTH AFRICA 1 30 N/A English 4.42 3 SOUTH KOREA 1 46 82 German 5.35 3 SPAIN 0 83 70 French 7.8 2 SWEDEN 1 17 57 Scandinavian 10 2 SWITZERLAND 1 88 70 German 10 1 THAILAND 1 39 N/A French 6.25 3 TURKEY 1 55 61 French 5.18 2 UNITED KINGDOM I 11 43 English 8.57 4 UNITED STATES 1 7 52 English 10 1 28 Table 3: Cross-Country Regressions The dependent variable is the ratio of the number of bankruptcies to the number of firms. The regressions are estimated using ordinary least squares with robust standard errors. LN(GDPPC) is the log of GDP Per Capita. GGDP is the 1-year growth rate of real GDP. D_SYSTCRISIS is a dummy equal to I in the case of a systemic bank crisis (Caprio and Klingebiel, 2000). RINTEREST is real interest rates. D_MKTORIENT is a dummy equal to I if the country is market-oriented and equal to 0 if the country is bank-oriented (Demirguc-Kunt and Levine, 1999). TIME is the number of business days required for a business to become operational (Djankov et al., 2000). SME SHARE is the percentage of total employment in the SME sector (Klapper and Sulla, 2002.) t-statistics are in parentheses, *, *, and *** indicate significance at 10%, 5%, and 1% respectively. (1) (2) (3) (4) (5) Base Market Business With Regression Orientation Entry SMEs Dummies 0.8904 0.1730 2.2350*** 4.1320*** -0.2300 Constant (1.53) (0.30) (3.73) (5.75) (-0.45) 0.0052*** 0.0053*** 0.0040*** 0.0054*** -0.0034 LN(GDPPC,.,) (5.34) (5.78) (4.03) (6.26) (-0.68) -0.0704*** -0.1003*** -0.0994*** -0.0206 -0.0101 GGDP ,, (-2.59) (-3.47) (-3.44) (-0.75) (-0.52) D SYSTCRISIS,-, 0.0692 0.3191 -0.2555 0.4553 0.7054*** D_SYSTCR!SIS,, (0.16) (0.77) (-0.63) (1.14) (3.05) -0.0052 -0.0087 0.0323*** -0.0199 0.0088 RINTEREST,, ](-0.63) (-1.07) (2.90) (-1.62) (1.34) D MKTORIENT ~~~1.1239*** D_MKTORIENT ________ (4.98) TIME -0.0208*** SM E_SHARE -0.0576*** _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ (-7 .5 4 ) Country Dummies No No No No Yes Year Dummies Yes Yes Yes Yes Yes Adj. R-Squared 0.14 0.24 0.31 0.36 0.91 Observations 273 273 265 243 273 29 Table 4: Cross-Country Regressions with Legal Orisins and Leual Efficiency The dependent variable is the ratio of the number of bankruptcies to the number of firms. The regressions are estimated using ordinary least squares with robust standard errors. LN(GDPPC) is the log of GDP Per Capita. GGDP is the 1-year growth rate of real GDP. D_SYSTCRISIS is a dummy equal to 1 in the case of a systemic bank crisis (Caprio and Klingebiel, 2000). RINTEREST is real interest rates. FRENCH, GERMAN, and SCANDINAVIAN are dummies indicating legal origin (La Porta, et al., 1998). RULE OF L4 W is an assessment of the "efficiency and integrity" of the legal environment as measure by Busines International Corp (La Porta, et al. 1998 and Berkowitz, et al., 2000.) CREDITOR RIGHTS is the sum of dummies identifying Restrictive Reorganizations, No Automatic Stay on Assets, Secured Creditors Paid First, and Management Does Not stay in Reorganization (La Porta, et al., 1998 and Pistor, 2000.) t-statistics are in parentheses, *, *, and *** indicate significance at 10%, 5%, and 1% respectively. (1) (2) (3) (4) _(5) Legal ~~~~~~Legal Creditor Ogalin Rule of Law Origin and Creditor R and Origin ~~~Rule of Rights Rule of Law _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ L aw 3.1452*** -0.4398 2.8068*** 0.9798* -0.3225 Constant (6.11) (-0.55) (4.53) (1.76) (-0.43) 0.0022*** 0.0020 0.0009 0.0052*** 0.0018 LN(GDPPC,,J (2.32) (1.57) (0.65) (5.33) (1.43) GGDPI-I -0.0990*** -0.0560** -0.0986*** -0.0705*** -0.0558** GG , (4.32) (-1.93) (4.26) (-2.59) (-1.92) 0.0666 0.0464 0.0657 0.0792 0.0620 D_SYSTCRlSlS,, Z(0.19) (0.11) (0.19) (0.18) (0.15) -0.0108* 0.0075 -0.0077 -0.0060 0.0064 RINTEREST,, (-1.61) (0.74) (-1.08) (-0.72) (0.65) FRENCH -~~2.352*** -2.3323*** FRENVCH -.5**-.33* r ~~~~~(-12.64) (-11.95) -2.3996*** -2.2680*** GERMAeN (-12.48) (-10.16) SCANDINA VUN 0. (01600*** 0.2032 SCA N DIN A VIA N ~~(0.34) _ _ _ _ _ _ (0.44) _ _ _ _ _ -2.4683*** -2.5908*** TRANSIT (-5.62) (-5.61) CREDITOR RIGHTS -0.0414 -0.0667 _____________________ _ __________ ____________ (-0 .5 4 ) (- 0.85 ) RULE OFLAW 0.2533*** 0.0725** 0.2584*** RULE OF LA W (2.89) (2.16) (2.81) Year Dummies Yes Yes Yes Yes Yes Adj. R-Squared 0.50 0.17 0.50 0.14 0.17 Observations 273 273 273 273 273 30 Table 5: Cross-Country Regressions with Creditor Rights and Legal Efficiency The dependent variable is the ratio of the number of bankruptcies to the number of firms. Transition countries are excluded from all regressions because of the unavailability of disaggregated creditor rights. The regressions are estimated using ordinary least squares with robust standard errors. LN(GDPPC) is the log of GDP Per Capita. GGDP is the 1-year growth rate of real GDP. D_SYSTCRISIS is a dummy equal to 1 in the case of a systemic bank crisis (Caprio and Klingebiel, 2000). RINTEREST is real interest rates. CREDITOR RIGHTS is the sum of dummies identifying Restrictive Reorganizations, No Automatic Stay on Assets, Secured Creditors Paid First, and Management Does Not stay in Reorganization (La Porta, et al., 1998) RULE OF LAW is an assessment of the "efficiency and integrity" of the legal environment as measure by Business Intemational Corp (La Porta, et al. 1998 and Pistor, 2000.) t-statistics are in parentheses, *, *, and *** indicate significance at the 10%, 5%, and 1% respectively. (1) (2) (3) (4) (5) Creditor Restrictive No Automatic Secured Management Rights Reorganization Asets Paid First Does Not Stay -0.3620 -0.4936 0.0931 -0.2632 -0.6489 Constant (-0.44) (-0.59) (-0.11) (-0.32) (-0.85) -0.0011 -0.0014 -0.0014 -0.0012 -0.0010 LN(GDPPC,1-) (-0.65) (-0.82) (-0.80) (-0.71) (-0.57) -0.1040** -0.1068*** -0.0993*** -0.1024** -0.1060*** GGDP ,, (-2.44) (-2.65) (-2.56) (-2.37) (-2.55) 0.3072 0.3739 0.1153 0.3444 0.2558 D_SYSTCRISIS,., (0.58) (0.72) (0.22) (0.64) (0.46) RINTEREST,_1 0.0004 -0.0007 -0.0114 -0.0025 0.0074 RINTEREST,, (0.03) (-0.04) (-0.77) (-0.16) (0.47) CREDITOR RIGHTS (-0.34)1 RESTRICTIVE 0.5378** REORGANIZATION (2.12) NO A UTOMA TIC STA Y -0.9093 *** ONASSETS (4.75) SECURED CREDITOR -0.2384 PAID FIRST (-0.77) MANAGEMENT DOES 0.2073 NOTSTAY (0.79) RULE OF LAW 0.3506*** 0.3393*** 0.3715*** 0.3623*** 0.3654*** (3.61) (3.76) (3.83) (3.55) (4.28) Year Dummies Yes Yes Yes Yes Yes Adj. R-Squared 0.18 0.20 0.23 0.18 0.18 Observations 252 252 252 252 252 31 Table 6: Cross-Country Regressions with Creditor Rights and Legal Efficiencv The dependent variable is the ratio of the number of bankruptcies to the number of firms. Transition countries are excluded from all regressions because of the unavailability of disaggregated creditor rights. The regressions are estimated using ordinary least squares with robust standard errors. LN(GDPPC) is the log of GDP Per Capita. GGDP is the 1-year growth rate of real GDP. D_SYSTCRISIS is a dummy equal to 1 in the case of a systemic bank crisis (Caprio and Klingebiel, 2000). RINTEREST is real interest rates. CREDITOR RIGHTS is the sum of dummies identifying Restrictive Reorganizations, No Automatic Stay on Assets, Secured Creditors Paid First, and Management Does Not stay in Reorganization (La Porta, et al., 1998) RULE OF LAW is an assessment of the "efficiency and integrity" of the legal environment as measure by Business International Corp (La Porta, et al. 1998 and Pistor, 2000.) t-statistics are in parentheses, *, *, and *** indicate significance at the 10%, 5%, and 1% respectively. (1) (2) (3) (4) (5) Creditor Restrictive No Automatic Creditor Management Rights Reorganization Stay on Assets Paid First Does Not Stay -2.6197*** -2.0861*** 0.2174 -1.0766 -2.3879*** Constant (-3.23) (-3.09) (0.24) (-1.46) (-3.19) 0.0010 0.0001 -0.0019 -0.003 -0.0001 LN(GDPPC,d) (0.51) (0.07) (-1.09) (-0.17) (-0.35) -0.0817** -0.0669* -0.0937 -1.011 *** -0.0609 CGDP ,, (-2.07) (-1.75) (-2.47) (-2.38) (-1.52) D SYSTCRISIS,, 0.2075 0.5557 0.2499 0.3105 0.4216 (0.38) (1.05) (0.48) (0.56) (0.80) RINTEREST,j 0.0401* 0.0270* -0.0184 0.0108 0.0339* ,-1 ~~~~~(1.87) (1.68) (-1.14) (0.53) _ (1.87) CREDITOR RIGHTS 1.2829*)* _ RESTRICTIVE 4.3785*** REORGANIZATION (3.35) NO AUTOMA TIC STA Y -2.4162*** ONASSETS (-2.95)., SECURED CREDITOR 0.9607* PAID FIRST (1.76) MANAGEMENT DOES 4.3929*** NOTSTAY . (3.35) 0.5479*** 0.4629*** 0.3499*** 0.4423*** 0.5273*** RULE OF LA W (6.10) (6.01) (3.53) (5.99) (5.77) RULE OFLA W* -0.1654*** CREDITOR RIGHTS (-2.89) . RULE OF LA W * RESTRICTIVE -0.4602*** REORGANIZATION (-2.97) LEALITY* NO A UTOMA TIC 0.1785* STAY ONASSETS (1.88) RULE OF LA W* SECURED -0.1579 CREDITOR PAID FIRST (-1.12) RULE OF LA W* MANAGEMENT -0.5447*** DOES NOT STA Y (-3.30) Year Dummies Yes Yes Yes Yes Yes Adj. R-Squared 0.22 0.25 0.24 0.19 0.23 Observations 252 252 252 252 252 32 APPendix 1: Sources of Bankruptcv Data Country Source A USTRALIA Australian Securities and Investment Commission BELGIUM National Statistical Office CANADA Office of The Superintendent Of Bankruptcy CHILE Fiscal Nacional De Quiebras COLOMBIA Supersociedades CZECHREPUBLIC European Bank of Research and Development (EBRD) DENMARK Statistics Denmark FINLAND Statistics Finland FRANCE Institut National de la Statistique et des Etudes Economiques (INSEE) GERMAN'Y Wirtschaftsanalyse GREECE National Statistical Service of Greece HONG KONG Government of Hong Kong -HUNGARY EBRD IRELAND Dept of Enterprise, Trade and Employment ITALY Annuario di Statisticeh Giudiziarie JAPAN Teikoku Data Bank KOREA OECD S ecial Report NETHERLANDS Statistics Netherland NEWZEALAND NZ Insolvency and Trustee Service NORWAY Statistics Norway PERU INDECOFI POLAND EBRD PORTUG-AL Ministry of Justice RUSSIA Russian Economic Trends Quarterly - Center for Economic Reforms SINGAPORE Official Receiver and Public Trustee Office, Singapore SPAIN National (Spanish) Statistics Institute SWEDEN Statistics Sweden SWITZERLAND Schweizerischen Verband Creditform THAILAND Statistical Office TURKEY Government of Turkey UNITED KINGDOM Departmnent of Trade and Industry UNITED STA TES American Bankruptcy Institute 33 Appendix 2: Bankruptcv Laws on the Books County Liquidation Reorganization Procedure Procedure ARGENTINA 1 1 AUSTRALIA 1 1 A USTRIA I 1 BELGIUM 1 1 CANADA 1 1 CHLE 1 1 COLOMBIA 1 I CYPRUS 1 1 CZECHREP 1 1 DENMARK 1 1 FINLAND 1 0 FRANCE 1 1 GERMANY 1 1 HONG KONG 1 I HUNGARY 1 1 ICELAND 1 1 IRELAND 1 1 ISRAEL 1 1 ITALY 1 1 JAPAN 1 1 NETHERLANDS 1 1 NEWZEALAND 1 0 NORWAY 1 1 PERU 1 1 POLAND 1 1 PORTUGAL 1 I 1 RUSSIANFED 1 I SINGAPORE 1 1 SLOVAKIA I 1 SOUTHAFRICA I 1 SPAIN 1 1 SWEDEN 1 1 SWITZERLAND 1 1 THAILAND 1 1 TURKEY 1 1 UK 1 1 USA 1 URUGUAY 1 1 34 Policy Research Working Paper Series Contact Title Author Date for paper WPS2837 Reform, Growth, and Poverty David Dollar May 2002 E. 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Geller Multiple Cycle Extraction in a 85155 Cointegration Framework WPS2845 The Spatial Division of Labor Marcel Fafchamps May 2002 F. Shilpi in Nepal Forhad Shilpi 87476 WPS2846 Is India's Economic Growth Leaving Gaurav Datt May 2002 C. Cunanan the Poor Behind? Martin Ravallion 32301 WPS2847 The Nature and Dynamics of Poverty Hippolyte Fofack May 2002 P. White Determinants in Burkina Faso 81131 in the 1990s WPS2848 Administrative Barriers to Foreign Jacques Morisset May 2002 M. Feghali Investment in Developing Countries Olivier Lumenga Neso 36177 WPS2849 Pooling, Savings, and Prevention: Truman G. Packard May 2002 T. Packard Mitigating the Risk of Old Age 75841 Poverty in Chile WPS2850 Determinants of Commercial Bank David A. Grigorian June 2002 S. Torres Performance in Transition: An Vlad Manole 39012 Application of Data Envelopment Analysis WPS2851 Economic Development and the Bernard Hoekman June 2002 P. Flewitt World Trade Organization After Doha 32724 WPS2852 Regional Agreements and Trade in Aaditya Mattoo June 2002 P. Flewitt Services: Policy issues Carsten Fink 32724 WPS2853 Private Interhousehold Transfers in Donald Cox June 2002 E. Khine Vietnam in the Early and Late 1990s 37471 Policy Research Working Paper Series Contact Title Author Date for paper WPS2854 Rich andPowerful? Subjective Michael Lokshin June 2002 C. Cunanan Power and Welfare in Russia Martin Ravallion 32301 WPS2855 Financial Crises, Financial Luc Laeven June 2002 R. Vo Dependence, and Industry Growth Daniela Klingebiel 33722 Randy Kroszner WPS2856 Banking Policy and Macroeconomic Gerard Caprio. Jr. June 2002 A. Yaptenco Stability: An Exploration Patrick Honohan 31823 WPS2857 Markups, Returns to Scale, and Hiau Looi Kee June 2002 M. Kasilag Productivity: A Case Study of 39081 Singapore's Manufacturing Sector WPS2858 The State of Corporate Governance: Olivier Fremond June 2002 G. Gorospe Experience from Country Mierta Capaul 32623 Assessments WPS2859 Ethnic and Gender Wage Mohamed Ihsan Ajwad June 2002 Z. Jetha Disparities in Sri Lanka Pradeep Kurukulasuriya 84321 WPS2860 Privatization in Competitive Sectors: Sunita Kikeri June 2002 R. Bartolome The Record to Date John Nellis 35703 WPS2861 Trade-Related Technology Diffusion Maurice Schiff June 2002 M. Kasilag and the Dynamics of North-South Yanling Wang 39081 and South-South Integration Marcelo Olarreaga WPS2862 Tenure, Diversity, and Commitment: Somik V. Lall June 2002 Y. D'Souza Community Participation for Urban Uwe Deichmann 31449 Service Provision Mattias K. A. Lundberg Nazmul Chaudhury WPS2863 Getting Connected: Competition Frew Amare Gebreab June 2002 P. Sintim-Aboagye and Diffusion in African Mobile 38526 Telecommunications Markets WPS2864 Telecommunications Reform in Mary M. Shirley June 2002 P. Sintim-Aboagye Uganda F. F. Tusubira 38526 Frew Amare Gebreab Luke Haggarty