2016 GCGC

10-11 June 2016

Corporate Leverage and Employee Protection in Bankruptcy


Marco Pagano

Professor of Finance University of Naples Federico II


Merrit Fox

Michael E. Patterson Professor of Law, NASDAQ Professor for Law and Economics of Capital Markets


The seniority of employees’ claims in the liquidation of insolvent firms, and their rights in the renegotiation of their debt varies greatly across countries. We show that the balance between these rights of employees and those of other creditors should affect the leverage chosen by firms.

In a simple model of strategic leverage, employees’ seniority is predicted to increase the positive response of leverage to appreciation of its real estate or an increase in its revenue, while stronger employees’ rights in the renegotiation of corporate debt have the opposite effect. These predictions differ starkly from those that obtain if firms’ leverage is determined by a collateral constraint. To test them, we construct novel measures of employees’ protection in bankruptcy via questionnaires to law firms and other sources, and investigate whether these measures affect the response of firm leverage in a sample of 12,445 companies in 28 countries between 1988 and 2013.

We find that increases in the value of these firms’ real estate is associated with a greater increase in leverage for companies located in countries where employees have stronger seniority in company liquidation and weaker rights in debt renegotiation, as predicted by the strategic leverage model. For a subsample of 928 mining and oil companies, we find a similar differential response of leverage to profitability shocks resulting from changes in the prices of the commodities produced by these companies.

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