“Results show that better enforceability of contracts increases loan size, lengthens loan maturity, and reduces loan spreads,” Bae and Goyal write. In fact, the average loan amount jumps by about $57 million if a borrower moves from the country with the weakest protection of property rights to the one with the strongest, all other factors remaining equal. That’s not all. The average loan maturity increases by 2.5 years, while the average loan spread drops by 67 basis points.
As Bae and Goyal note, in countries in which creditor rights are weak or poorly enforced, banks can be expected to charge higher interest rates Big Fat Finance, lend less, and/or shorten loan maturities. To determine how much of an impact creditor rights have, the duo examined some 63,000 loans issued between 1994 and 2003 to firms in 48 countries.
Treasurers and CFOs know that the extent to which creditors’ rights are protected in different countries affects just how much and to whom lenders are willing to extend credit. Indeed, a recent study, “Creditor Rights, Enforcement, and Bank Loans,” by Kee-Hong Bae at York University and Vidhan Goyal at the Hong Kong University of Science and Technology, illustrates the dramatic impact creditor protection can have. The study appeared in the April 2009 issue of the Journal of Finance.
How can treasurers apply this information to their own firms? Goyal suggests several steps. First, they can use different indices, such as the International Country Risk Guide, to assess just how well different countries’ legal systems enforce contracts.
In addition, when firms find opportunities worth pursuing in countries not known for enforcing creditor rights, their financial team will want to bring a strong reputation for honoring contracts, Goyal notes. That can help alleviate concerns their banking partners may have about loaning money to support their ventures there. ###
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