Description
The purpose of this paper is to study the effect of changes in creditors’ priority defined by
the bankruptcy law on firms’ capital structure.
Journal of Financial Economic Policy
Firms' capital structure and the bankruptcy law design
Bruno Funchal Mateus Clovis
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Bruno Funchal Mateus Clovis, (2009),"Firms' capital structure and the bankruptcy law design", J ournal of
Financial Economic Policy, Vol. 1 Iss 3 pp. 264 - 275
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dx.doi.org/10.1108/03074350710739605
W. Adrián Risso, Edgar J . Sánchez Carrera, (2009),"Inflation and Mexican economic growth: long-run
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dx.doi.org/10.1108/17576380911041728
Anthony Kyereboah-Coleman, (2007),"The impact of capital structure on the performance
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Firms’ capital structure and the
bankruptcy law design
Bruno Funchal and Mateus Clovis
FUCAPE Business School, Vito´ria, Brazil
Abstract
Purpose – The purpose of this paper is to study the effect of changes in creditors’ priority de?ned by
the bankruptcy law on ?rms’ capital structure.
Design/methodology/approach – Taking advantage of the Brazilian bankruptcy law reform as an
experiment and using publicly traded ?rms’ balance sheet data, it compares Brazilian ?rms capital
structure before and after the new law, using ?xed-effects panel regression. The empirical results are
in line with theories that predict the effects on the capital structure due to changes in creditors’
expectations.
Findings – This paper ?nds evidence of an increase in the debt portion of the capital structure.
Originality/value – The paper contributes the law and ?nance empirical literature, pointing out that
change in creditors’ protection induces signi?cant changes in the ?rms’ ?nancing policy.
Keywords Capital structure, Bankruptcy, Government policy, Regulation, Law, Brazil
Paper type Research paper
I. Introduction
The goal of this paper is to study the impact of institutional changes – more speci?cally
changes in the bankruptcy law – on ?rms’ ?nancing choices, in other words, their
capital structure.
Since, the seminal paper of Modigliani and Miller (1958), scholars have discussed the
capital structure choice. The most important departures from Modigliani and Miller’s
assumptions that make capital structure relevant to a ?rm’s value are known. Empirical
studies have reported some stylized facts on capital structure choice, but this evidence is
largely based on ?rms in the USA (Titman and Wessels, 1988), and it is not at all clear
how these facts relate to different economic environments. Hence, one cannot only rely
on existing ?ndings in economics and corporate ?nance, because countries differ in their
economic environments.
In the empirical ?eld, Booth et al. (2001), using data fromdeveloping countries, studied
the stylized facts about capital structure beyond the developed countries. They found that
the variables relevant to explain capital structure in the USAand Europe are also relevant
in developingcountries, despite the differences ininstitutional factors. Rajan and Zingales
(1995) analyzed factors that in?uence the capital structure, including the institutional
differences, across the G-7 countries. Our paper focuses on one particular institution:
the bankruptcy law. We analyze how relevant creditors’ priority is for the ?rms’ capital
structure, especially in an institutional setting that provides a low level of creditors’
protection. We base this analysis on the 2005 Brazilian bankruptcy law reform.
Scott (1977) theoretically addressed the relationship between capital structure and
bankruptcy. He argued that when ?rms sell secured debt, they are not only selling a
The current issue and full text archive of this journal is available at
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JEL classi?cation – G32, G33, G38, K00
JFEP
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Journal of Financial Economic Policy
Vol. 1 No. 3, 2009
pp. 264-275
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/17576380911041737
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promise of future repayment, but also rather the right to be the ?rst in order of priority in
case of bankruptcy. Thus, the priority order de?ned by the bankruptcy law has a
signi?cant value since it reduces the chance that debtors will not be repaid. This value
impacts the debt cost of debt and as a consequence the capital structure.
Taking advantage of the 2005 Brazilian bankruptcy law reform as an experiment,
this paper measures the impact of changes in the design of the bankruptcy law, mainly
due to the abrupt change in creditors’ priority, on ?rms’ choice of capital structure.
Intuitively, since the new bankruptcy law has improved creditors’ priority, their
expectations about recovery in insolvency states should increase. The more creditors
expect to receive in bankruptcy, the less they will require ?rms to pay in solvency, thus
reducing the cost of capital. A lower cost of debt ?nancing encourages ?rms to increase
the share of debt in their capital structure.
By estimating an econometric model (panel with ?xed effects) to measure the effect of
the changes in creditors’ priority order on ?rm-level capital structure, we ?nd an
increase of approximately 8.4 percent, on average, of the share of debt in the capital
structure. This effect is divided into increases of 3.6 and 4.8 percent in the share of short-
and long-term debt, respectively. Moreover, during the studied period, Brazil was
experiencing a period of high appreciation in its capital markets, making equity
?nancing more attractive. This feature reinforces the effect of bankruptcy reform on the
share of debt.
This result suggests that reforms of the bankruptcy law design that modify the
priority of stakeholders have a signi?cant impact on ?rms ?nancing policy. Therefore,
policy makers should keep in mind that by improving creditors’ priority, the cost of debt
will be reduced, making ?rms less credit constrained and motivating an increase in their
share of debt in the capital structure.
The remainder of the paper is organized as follows: Section II discusses the Brazilian
bankruptcy reform and its potential effects; Section III presents the empirical results;
and Section IV concludes.
II. The Brazilian bankruptcy law reform
The former legal framework for corporate insolvency in Brazil was very fragmented, with
the core of legislation for bankruptcy proceedings enacted in 1945. Despite providing
both liquidation and reorganization mechanisms to prevent or reduce the liquidation of
enterprises, in practice, the insolvency process was ineffective at maximizing asset values
and protecting creditor rights in liquidation. The bankruptcy priority rule speci?ed the
following priority order: ?rst, labor claims; second, tax claims; third, secured creditors’
claims; and ?nally, unsecured creditors’ claims (including trade credit).
The process of disposing of assets was also slow and highly ineffective, because of
court and procedural inef?ciency, lack of transparency, and the so-called problema da
sucessa˜ o, whereby tax, labor, and other liabilities were transferred to the buyer of a
liquidated asset sold in liquidation, which deteriorated the market value of an insolvent
company’s assets. In addition, the priority given to labor and tax claims had the practical
effect of eliminating any protection to other creditors. The former reorganization
procedure (called concordata) was a process that postponed debt payment only and did
not deal with ?rms’ restructuring.
On June 9, 2005, the new legislation on bankruptcy (Law 11,101/05) took effect. The
new liquidation procedure introduced six key changes. First, labor credits are limited
Firms’ capital
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to an amount equaling 150 times the minimummonthly wage[1]. Second, secured credits
are nowgiven priority over tax credits. Third, unsecured credits are given priority above
some of the tax credits. Fourth, the distressed ?rm may be sold (preferably as a whole)
before the creditors’ list is constituted, which can speed up the process and increase the
value of the bankruptcy estate. Fifth, tax, labor, and other liabilities are no longer
transferred to the buyer of an asset sold in liquidation. Finally, any new credit extended
during the reorganization process is given ?rst priority in the event of liquidation.
The ?rst two changes have had a direct impact on secured creditors’ priority. Since
under the former bankruptcy law, secured creditors came after all labor and tax claims,
the priority given to secured creditors has increased signi?cantly. The third one has
increased unsecured creditors’ priority. The fourth, ?fth, and sixth changes, in turn, are
expected to increase the value of ?rms in bankruptcy and as a consequence the amount
recovered by creditors. The more creditors expect to receive in the insolvency state, the
less they will require ?rms to pay in the solvency state, thus reducing the cost of capital.
Brazil’s new reorganization procedure was inspired by Chapter 11 in the US
bankruptcy code. Whereas the previous law did not permit any renegotiation between
the interested parties and only a few parties were entitled to recover their assets, now
managers make a sweeping proposal for recuperation that must either be accepted by
workers, secured creditors and unsecured creditors (including trade creditors) or the
distressed ?rm will be liquidated. Creditors play a more signi?cant role in the procedure
than previously, including negotiating and voting for the reorganization plan. Table I
summarizes the main changes in the Brazilian bankruptcy law.
Some data on creditors’ recovery rate will help to illustrate the main effects of the
bankruptcy law reform. Before the reform, the recovery rate in the case of bankruptcy
was a mere US$0.002 on the dollar in Brazil, while the average of Latin American and
Organization for Economic Cooperation and Development (OECD) countries was
US$0.27 and 0.66, respectively[2]. Basically, the reason for such low recovery was the
priority order, since creditors ranked behind labor and tax claims. Thus, the remaining
amount from the bankruptcy process used to pay creditors was usually insigni?cant
or nil.
New law Former law
Liquidation
Priority order
Secured
creditors
Second in the priority order: after labor
claims limited to 150 minimum monthly
wages
Third in the priority order: after labor
and tax claims
Unsecured
creditors
Fourth in the priority order: after labor,
secured creditors, and some tax claims
Fourth in the priority order: after labor,
secured creditors, and tax claims
Liabilities Tax, labor, and other liabilities are no
longer transferred to the buyer of an
asset sold in liquidation
Tax, labor, and other liabilities were
transferred to the buyer of a liquidated
property sold in liquidation
Reorganization
Postbankruptcy
credit
First to receive if the ?rm goes to
liquidation
Third to receive if the ?rm goes to
liquidation, after labor and tax claims
Role of
creditors
Creditors negotiate and vote for the
reorganization plan
None
Table I.
The main changes in the
Brazilian bankruptcy law
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As a consequence, of the bankruptcy reform, in 2006 creditors’ recovery rate increased to
US$0.12 onthe dollar inBrazil, while the average of Latin American and OECDcountries
remained stable (US$0.29 and 0.67, respectively)[3].
The effects on debt ?nancing: a simple model
The relationship between the bankruptcy design and its effects on cost of capital can
be illustrated using a simple model. Suppose that:
.
H1 – the borrowing ?rm is run by an owner/manager;
.
H2 – capital markets are competitive;
.
H3 – creditors can predict their mean pay-offs in the default state; and
.
H4 – creditors and the ?rm are risk-neutral.
We make the ?rst assumption because we are not dealing with the corporate governance
problem. The second assumption is realistic. The third rests on the view that
professional creditors have considerable experience with default, and the fourth is more
accurate when applied to ?rms than to individual persons.
The borrowing ?rm has a project that requires capital, I, which the ?rm must raise
externally. The ?rm promises to repay creditors the sum, F (where F ¼ I ð1 þ rÞ). The
project can return a value, v, where the ?rmis solvent if v $ Fand insolvent if v , F. Two
states of nature are possible in the future, one if the ?rmis solvent and the other if it is not.
The solvency and insolvency states return to the ?rm v
solv
and v
ins
, respectively,
where v
solv
$ F . v
ins
. The probability of solvency is p
solv
; the probability of insolvency
is ð1 2p
solv
Þ. This implies that the expected value of the project is
EðvÞ ¼ p
solv
v
solv
þ ð1 2p
solv
Þv
ins
. The bankruptcy system costs c to run. A
bankruptcy system can thus distribute to the creditors of an insolvent ?rm at most
the sum v
ins
2c, so the repayment to creditors is F if the ?rm is solvent and v
ins
2c if it
goes bankrupt and if creditors are the ?rst to receive in the priority rule.
Because the credit market is competitive, F is the largest sum that creditors can
demand to fund the project. For simplicity, the risk-free interest rate is assumed to be
zero, so that a borrowing ?rm’s interest rate is a function only of the riskiness of its
project and the properties of the bankruptcy system in place.
Creditors that lend I should expect to receive I in return. This expectation can be
written as follows:
I ¼ p
solv
F þ ð1 2p
solv
Þðv
ins
2cÞ
F ¼
I 2ð1 2p
solv
Þðv
ins
2cÞ
p
solv
:
If the bankruptcy law decrees, the priority of tax (t) and/or labor (l ) claims over secured
creditors’ claims, creditors will receive the maximum between the zero and
ðv
ins
2c 2l 2tÞ. Then, the ?nancing condition for creditors is:
I ¼ p
solv
F þ ð1 2p
solv
Þmaxðv
ins
2c 2l 2t; 0Þ:
Notice that creditors’ insolvency recovery may fall to zero in this situation, which would
strongly increase the cost of capital, and therefore, an improvement in creditors’ priority
raises their recovery rate, as occurred in Brazil right after the new law went into force.
Firms’ capital
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If the expected value that creditors recover in insolvency states increases (that is,
maxðv
ins
2c 2l 2t; 0Þ rises to maxðv
ins
2c 2
l; 0Þ, where
l is the labor claims limited
to 150 times the monthly minimum wage), then F declines, diminishing the interest rate
charged by creditors.
The more that creditors expect to receive in the insolvency state, the less they will
require the ?rm to repay in the solvency state. The ?rm’s interest rate is r ¼ ðF=I Þ 21,
which is increasing in F.
Denoting by v
u
ins
, c
u
and
l
u
the per-unit-of-investment (I ¼ 1) counterparts of v
ins
,
c and
l, we also have:
r ¼
ð1 2p
solv
Þ
p
solv
1 2max v
u
ins
2c
u
2
l
u
; 0
À Á Â Ã
;
which is decreasing in recovery rate in insolvency states:
P1. The priority of creditors’ claims over labor and/or tax claims decreases the
cost of capital.
Therefore, the increase in recovery rate is a natural consequence of an improvement in
creditors’ priority, as evidenced in Brazil. Figure 1, which presents the evolution in
creditors’ recovery rate, shows an abrupt increase in this rate after the reform. Since the
newlawtook effect in June 2005, all the procedures thereafter have followed the newrule,
increasing the recovery rate from¢0.2 on the dollar in 2004 to ¢12, 14 and 17 on the dollar
in 2006, 2007, and 2008, respectively.
As expectedbyP1, there was a reductioninthe cost of debt toBrazilian?rms (Figure 2).
Notice that the downward trend starts just after the Brazilian bankruptcy reform, and,
therefore, ceteris paribus, more projects tend to be ?nanced using debt instead of equity.
III. Empirical results
In this paper, we used ?rm-speci?c accounting data[4] for 389 publicly traded ?rms from
2002 to 2007[5]. We considered as ?rmshare of debt in the capital structure[6], the sumof
short-termdebt, long-termdebt, and accounts payable[7] divided by the ?rmvalue (total
debt plus market value).
We also separately analyzed the effect on the short-term debt share (short-term debt
plus accounts payable divided by the ?rm value) and long-term debt share (long-term
debt divided by ?rmvalue), used as proxies of unsecured and secured debt, respectively.
Since the priority changes differently for secured and unsecured creditors, we expect
different effects on both types of credit.
Figure 1.
Evolution of creditors’
recovery rate
Creditors’ recovery rate
0
4
8
12
16
20
2003 2004 2005 2006 2007 2008 2009
C
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a
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Source: Doing business – World Bank
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Table II reports the descriptive statistics of our variable of interest (share of debt in the
capital structure). Notice that the share of debt (total, short-term, and long-term) presents
a downward trend from the period before to after the bankruptcy reform. The mean of
the share of debt went down from51 percent before the newlawto 35 percent afterward,
which means in relative terms a reduction of 31 percent of debt in the capital structure
(16 percent of 51 percent).
This downward trend is somewhat unexpected. We observe in the descriptive
statistics, for the pre- and post-bankruptcy reform period, a reduction in the share of debt,
although we expect a contrary tendency due to a reduction in the cost of capital (P1).
The explanation for this trend is the signi?cant increase of the market value of
Brazilian ?rms, and since the market value is used to measure the share of debt (total
debt divided by the ?rm value, where the ?rm value is total debt plus market value),
this increase directly affected our capital structure metric.
Figure 3 shows that the level of the Sa˜o Paulo Stock Market Index (IBOVESPA)
?uctuated between 9,000 and 25,000 points from 2002 to 2004, while it ?uctuated
between 25,000 and 65,000 points in 2005-2007. This trend encouraged ?rms to ?nance
themselves by issuing equity, reducing the portion of debt in the capital structure.
Mean SD
Before the bankruptcy law reform (2002-2004)
Total debt 0.51 0.28
Short-term debt 0.32 0.24
Long-term debt 0.19 0.19
After the bankruptcy law reform (2005-2007)
Total debt 0.35 0.26
Short-term debt 0.20 0.21
Long-term debt 0.14 0.16
All period (2002-2007)
Total debt 0.43 0.29
Short-term debt 0.26 0.23
Long-term debt 0.17 0.18
Table II.
Descriptive statistics –
share of debt
Figure 2.
Evolution of ?rms’ cost of
debt
Firms’ cost of debt
15
20
25
30
35
40
45
J
a
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-
0
2
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-
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2
S
e
p
-
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2
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a
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S
e
p
-
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e
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p
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7
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t
r
a
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Source: Brazilian central bank
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Thus, two important issues must be observed: ?rst, it is important to set the Sa˜o Paulo
Stock Market Index (in logs) as a control for the capital market trend in our empirical
model; second, the Brazilian economic environment provides a unique characteristic for
this research, since the reform was enacted in a period where equity ?nancing was very
attractive, reinforcing the potential impact of the bankruptcy reformon debt share in the
capital structure.
In addition, the Sa˜o Paulo Stock Exchange, we used as control variables the amount
of ?rms’ assets in thousands of Brazilian Reais[8] (logarithm) and macroeconomic data,
such as the logarithm of the real gross domestic product (GDP) in millions of Brazilian
Reais (logarithm), in?ation index[9], risk-free interest rate (SELIC and the benchmark
rate) and Brazilian global bonds in basis points. The GDP variable was used to control
our estimation for business cycles. The in?ation and the risk-free interest rates were
included to control for the trend of prices and the risk-free component of the cost of debt,
respectively, common to all ?rms, and the Brazilian Global Bonds to control for the risk
perception of investors. The data were obtained from both the Economatica and
Ipeadata databases (www.ipeadata.gov.br). Table III summarizes the descriptive
statistics of all control variables.
To estimate the impact of changes in creditors’ priority brought by the new Brazilian
bankruptcy lawon?rms’ share of debt (total, short-term, andlong-term), we useda panel
regression with cross-?rm ?xed effects, represented by the following functional form:
share_debt
it
¼ a
i
þ g
1
d_BR
t
þ GX
it
þ 1
it
: ð1Þ
The main results come fromthe bankruptcy lawreformdummy (d_BR), which assumes
zero for the pre-reformperiod (2002-2004) and one for the post-reformperiod (2005-2007).
The set of controls is represented by the vector X
it
.
The results of regression (1) reported in Table IV indicate that the bankruptcy law
reform had a signi?cant impact on the capital structure[10],[11]. Panels A-C show that
due to the bankruptcy reform, ?rms increased their share of debt by 8.4 percent, of which
3.6 percent represents short-term debt and 4.8 percent long-term debt. In relative terms,
the share of total debt went up approximately 17 percent (8.4 percent of 51 percent),
while the share of long-term debt increased 25 percent and the short-term debt only
11 percent.
This empirical result is aligned with our theoretical predictions. Intuitively, the
improvement in creditors’ priority reduces their risk of not getting repaid, making debt
Figure 3.
Sa˜o Paulo Stock Market
Index (IBOVESPA)
IBOVESPA
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
0
1
.
2
0
0
0
0
6
.
2
0
0
0
1
1
.
2
0
0
0
0
4
.
2
0
0
1
0
9
.
2
0
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0
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2
0
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2
0
7
.
2
0
0
2
1
2
.
2
0
0
2
0
5
.
2
0
0
3
1
0
.
2
0
0
3
0
3
.
2
0
0
4
0
8
.
2
0
0
4
0
1
.
2
0
0
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0
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?nancing cheaper and as a consequence, motivating ?rms to resort to debt. Thus,
despite the downward trend of debt ?nancing (as seen in Table II), the bankruptcy
reform induced an increase of the share of debt in the capital structure.
But why do we observe a stronger effect on long-termdebt compared with short-term
debt? This can be explained by the difference in the change of priorities to secured
debtors and unsecured creditors. The Brazilian reform bene?ts secured creditors more
than unsecured ones because they have passed to second in priority, just after labor
claims (limited to 150 times the minimum monthly wage) (Table I).
To better understand the capital structure choice, now we explore ?rms’
heterogeneous responses to the bankruptcy reform. We study ?rms’ capital structure
choice as a function of their relative size, using total assets (logarithm) as a measure of
?rms’ size. Firms with more assets should be less sensitive to the reform since they can
?nance themselves by debt more easily using their assets as collateral.
To analyze heterogeneity, we add one term in regression (1):
share_debt
it
¼ a
i
þ g
1
d_BR
t
þ g
2
ðd_BR
t
· ASSETS
it
Þ þ GX
it
þ1
it
; ð2Þ
where the interaction of the bankruptcy reform dummy and the logarithm of ?rm
assets (d_BR· ASSETS) captures the ?rm-size effect.
Table V presents the results[10],[11]. Panels A and C show that the bankruptcy
reformprovided anincrease inthe debt portion, which is stronger for smaller ?rms, since
the interacted variable d_BR· ASSETS has a negative sign. This impact is signi?cant
for the share of total and long-term debt. However, the result is not the same for
short-term debt alone (Panel B). Since such debt does not require collateral, it is also
expected that the amount of assets should not affect unsecured debt ?nancing.
Mean SD
Before the bankruptcy law reform (2002-2004)
GDP (logarithm) 14.65 0.03
INFLATION (index) 119.00 14.69
SELIC (%) 19.07 2.93
GB (index) 910.00 338.35
IBOV (index) 15,755 4,260
ASSETS (logarithm) 13.32 2.30
After the bankruptcy law reform (2005-2007)
GDP (logarithm) 14.77 0.04
INFLATION (index) 147.93 4.10
SELIC (%) 15.50 2.90
GB (index) 216.94 108.10
IBOV (index) 40,428 12,188
ASSETS (logarithm) 13.36 2.48
All period (2002-2007)
GDP (logarithm) 14.71 0.07
INFLATION (index) 133.80 17.78
SELIC (%) 17.59 3.60
GB (index) 563.47 428.00
IBOV (index) 28,320 15,351
ASSETS (logarithm) 13.34 2.40
Table III.
Descriptive statistics –
control variables
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Figures 4 and 5 show the heterogeneous effect of the Brazilian bankruptcy law reform.
Computing the reform effect strati?ed by quartiles[12], we observe that it is stronger
for ?rms that hold lower amounts of assets.
The share of total and long-term debt increases almost 15 and 12 percent,
respectively, for the smaller ?rms, while it increases only 6 and 2 percent, respectively,
for bigger ?rms.
Therefore, we can conclude that although the change in bankruptcy law design has
had a signi?cant effect on ?rms’ ?nancing policy, it has had more relevance and bene?ts
for smaller ?rms.
IV. Conclusion
The main goal of this paper was to study the impact of changes in creditors’ priority
order on ?rms’ capital structure. To measure this effect, we took advantage of the recent
Coef?cient Robust SE p-value
Panel A: dependent variable: total debt
Intercept 21.360 22.130 0.950
d_BR 0.084 0.016 0.000
ASSETS 0.077 0.021 0.000
GDP 0.334 1.696 0.844
GB 20.008 0.010 0.392
SELIC 20.010 0.002 0.000
IBOV 20.397 0.281 0.157
Number of observations: 1,541, R
2
: 0.106, F-statistic: 74.49
Panel B: dependent variable: short-term debt
Intercept 230.80 21.56 0.153
d_BR 0.036 0.015 0.016
ASSETS 0.049 0.018 0.005
GDP 2.540 1.655 0.124
GB 20.022 0.010 0.025
SELIC 20.006 0.002 0.008
IBOV 20.678 0.278 0.015
Number of observations: 1,541, R
2
: 0.037, F-statistic: 74.44
Panel C: dependent variable: long-term debt
Intercept 29.44 20.17 0.145
d_BR 0.048 0.013 0.001
ASSETS 0.028 0.014 0.052
GDP 22.210 1.547 0.153
GB 0.014 0.010 0.128
SELIC 20.004 0.002 0.075
IBOV 0.280 0.258 0.278
Number of observations: 1,541, R
2
: 0.093, F-statistic: 11.58
Notes: This table presents the results of panel robust regressions, with ?xed effects, of the ?rms’
share of debt on bankruptcy reform variable (d_BR), which is represented by a dummy variable
codi?ed as 0 before 2005 and 1 after 2005; Panel A presents results for total debt share, while Panels B
and C present results partitioning by short- and long-term debt share; we control for the logarithm of
?rms’ assets (ASSETS) and for macroeconomic variables as the logarithm of GDP, Brazilian risk-free
interest rate (SELIC), the logarithm of Sa˜o Paulo Stock Market Index (IBOV) and Brazilian Global
Bonds in hundreds of points (GB)
Table IV.
Panel regression with
?xed effects: share of debt
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Brazilianbankruptcy lawreform, whose main change is the improvement of securedand
unsecured creditors’ priority.
Using data from ?rms’ balance-sheets and despite the trend for a fall in the share of
debt in the capital structure during 2002-2007, we found that the reform has brought an
increase of 8.4 percent, onaverage, of the debt share. This effect is divided into respective
increases of 3.6 and 4.8 percent in the short-term and long-term debt share. This is
explained by the improvement in creditors’ priority, since this reduces the chance of not
being repaid, decreasing the cost of debt and as a result motivating ?rms to resort to debt
funding.
We can also conclude that the bankruptcy law reform had a different effect on ?rms
?nancing policy depending on ?rm size, bene?ting smaller ?rms more.
Coef?cient Robust SE p-value
Panel A: dependent variable: total debt
Intercept 22.246 21.830 0.917
d_BR 0.246 0.057 0.000
d_BR
*
ASSETS 20.011 0.004 0.003
ASSETS 0.008 0.021 0.000
GDP 0.396 1.673 0.813
GB 20.009 0.009 0.344
SELIC 20.010 0.002 0.000
IBOV 20.411 0.277 0.138
Number of observations: 1,541, R
2
: 0.144, F-statistic: 69.91
Panel B: dependent variable: short-term debt
Intercept 230.588 21.594 0.157
d_BR 20.003 0.058 0.958
d_BR
*
ASSETS 0.002 0.004 0.466
ASSETS 0.047 0.018 0.009
GDP 2.530 1.658 0.127
GB 20.022 0.010 0.026
SELIC 20.006 0.002 0.008
IBOV 20.67 0.279 0.016
Number of observations: 1,541, R
2
: 0.032, F-statistic: 43.07
Panel C: dependent variable: long-term debt
Intercept 28.323 19.930 0.156
d_BR 0.250 0.051 0.000
d_BR
*
ASSETS 20.014 0.003 0.000
ASSETS 0.004 0.014 0.004
GDP 22.134 1.529 0.163
GB 0.012 0.009 0.153
SELIC 20.004 0.002 0.068
IBOV 0.263 0.256 0.303
Number of observations: 1,541, R
2
: 0.097, F-statistic: 12.89
Notes: This table presents the results of panel robust regressions, with ?xed effects, of the ?rms’
share of debt on bankruptcy reform variable (d_BR), which is represented by a dummy variable
codi?ed as 0 before 2005 and 1 after 2005; Panel A presents results for total debt share, while Panels B
and C present results partitioning by short- and long-term debt share; we control for the logarithm of
?rms’ assets (ASSETS) and for macroeconomic variables as the logarithm of GDP, Brazilian risk-free
interest rate (SELIC), the logarithm of Sa˜o Paulo Stock Market Index (IBOV) and Brazilian Global
Bonds in hundreds of points (GB)
Table V.
Panel regression with
?xed effects:
heterogeneous effect on
share of debt
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Notes
1. Brazil has a minimum monthly wage, called the sala´rio m? ´nimo, rather than a minimum
hourly wage.
2. Doing Business 2005 – World Bank.
3. Doing Business 2007 – World Bank.
4. Brazilian ?rms follow Brazilian Generally Accepted Accounting Principles in their ?nancial
reports.
5. Our study excludes all ?nancial ?rms, since the reform did not apply to them.
6. The end of the ?scal year.
7. We add accounts payable since trade credit is a relevant source of ?rms’ ?nancing (see
Love et al. (2007) and Nilsen (2002) for more details), and they were directly bene?ted by the
reform.
Figure 4.
Bankruptcy law effect on
the share of total debt
0.05
0.07
0.09
0.11
0.13
0.15
Min 0.25 0.50 0.75 Max
Assets percentile
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Figure 5.
Bankruptcy law effect on
the share of long-term debt
0
0.02
0.04
0.06
0.08
0.1
0.12
Min 0.25 0.50 0.75 Max
Assets percentile
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8. Brazilian Reais is the national currency.
9. Base year 2002.
10. In?ation was dropped due to multicollinearity.
11. Since the residuals in all regressions are heteroskedastic, we use robust standard errors in all
speci?cations.
12. The effect is calculated in the following way: ^ g
1
þ ^ g
2
· ASSETS
Quartile
:
References
Booth, L., Aivazian, V., Dermirguc-Kunt, A. and Maskimovic, V. (2001), “Capital structure in
developing countries”, The Journal of Finance, Vol. 56, pp. 87-130.
Love, I., Preve, L.A. and Sarria-Alende, V. (2007), “Trade credit and bank credit: evidence from
recent ?nancial crises”, Journal of Financial Economics, Vol. 83, pp. 453-69.
Modigliani, F. and Miller, M.H. (1958), “The cost of capital, corporation ?nance, and the theory of
investment”, American Economic Review, Vol. 48, pp. 261-97.
Nilsen, J.H. (2002), “Trade credit and the bank lending channel”, Journal of Money, Credit, and
Banking, Vol. 34, pp. 226-53.
Rajan, R. and Zingales, L. (1995), “What do we know about capital structure? Some evidence from
international data”, Journal of Finance, Vol. 50, pp. 1421-60.
Scott, J.H. Jr (1977), “Bankruptcy, secured debt, and optimal capital structure”, The Journal of
Finance, Vol. 32, pp. 1-19.
Titman, S. and Wessels, R. (1988), “The determinants of capital structure choice”, Journal of
Finance, Vol. 48, pp. 1-19.
About the authors
Bruno Funchal did his PhDin Economics at the Getu´lio Vargas Foundation, Brazil. He ?nished his
post-doc in Mathematical Economics at the National Institute of Pure and Applied Mathematics,
Brazil and is a Full Professor at the FUCAPEBusiness School. Bruno Funchal is the corresponding
author and can be contacted at: [email protected]
Mateus Clovis is a Master in Accounting at the FUCAPE Business School.
Firms’ capital
structure
275
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This article has been cited by:
1. Gary D. Holt. 2013. Construction business failure: conceptual synthesis of causal agents. Construction
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doc_227664946.pdf
The purpose of this paper is to study the effect of changes in creditors’ priority defined by
the bankruptcy law on firms’ capital structure.
Journal of Financial Economic Policy
Firms' capital structure and the bankruptcy law design
Bruno Funchal Mateus Clovis
Article information:
To cite this document:
Bruno Funchal Mateus Clovis, (2009),"Firms' capital structure and the bankruptcy law design", J ournal of
Financial Economic Policy, Vol. 1 Iss 3 pp. 264 - 275
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Firms’ capital structure and the
bankruptcy law design
Bruno Funchal and Mateus Clovis
FUCAPE Business School, Vito´ria, Brazil
Abstract
Purpose – The purpose of this paper is to study the effect of changes in creditors’ priority de?ned by
the bankruptcy law on ?rms’ capital structure.
Design/methodology/approach – Taking advantage of the Brazilian bankruptcy law reform as an
experiment and using publicly traded ?rms’ balance sheet data, it compares Brazilian ?rms capital
structure before and after the new law, using ?xed-effects panel regression. The empirical results are
in line with theories that predict the effects on the capital structure due to changes in creditors’
expectations.
Findings – This paper ?nds evidence of an increase in the debt portion of the capital structure.
Originality/value – The paper contributes the law and ?nance empirical literature, pointing out that
change in creditors’ protection induces signi?cant changes in the ?rms’ ?nancing policy.
Keywords Capital structure, Bankruptcy, Government policy, Regulation, Law, Brazil
Paper type Research paper
I. Introduction
The goal of this paper is to study the impact of institutional changes – more speci?cally
changes in the bankruptcy law – on ?rms’ ?nancing choices, in other words, their
capital structure.
Since, the seminal paper of Modigliani and Miller (1958), scholars have discussed the
capital structure choice. The most important departures from Modigliani and Miller’s
assumptions that make capital structure relevant to a ?rm’s value are known. Empirical
studies have reported some stylized facts on capital structure choice, but this evidence is
largely based on ?rms in the USA (Titman and Wessels, 1988), and it is not at all clear
how these facts relate to different economic environments. Hence, one cannot only rely
on existing ?ndings in economics and corporate ?nance, because countries differ in their
economic environments.
In the empirical ?eld, Booth et al. (2001), using data fromdeveloping countries, studied
the stylized facts about capital structure beyond the developed countries. They found that
the variables relevant to explain capital structure in the USAand Europe are also relevant
in developingcountries, despite the differences ininstitutional factors. Rajan and Zingales
(1995) analyzed factors that in?uence the capital structure, including the institutional
differences, across the G-7 countries. Our paper focuses on one particular institution:
the bankruptcy law. We analyze how relevant creditors’ priority is for the ?rms’ capital
structure, especially in an institutional setting that provides a low level of creditors’
protection. We base this analysis on the 2005 Brazilian bankruptcy law reform.
Scott (1977) theoretically addressed the relationship between capital structure and
bankruptcy. He argued that when ?rms sell secured debt, they are not only selling a
The current issue and full text archive of this journal is available at
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JEL classi?cation – G32, G33, G38, K00
JFEP
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Journal of Financial Economic Policy
Vol. 1 No. 3, 2009
pp. 264-275
qEmerald Group Publishing Limited
1757-6385
DOI 10.1108/17576380911041737
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promise of future repayment, but also rather the right to be the ?rst in order of priority in
case of bankruptcy. Thus, the priority order de?ned by the bankruptcy law has a
signi?cant value since it reduces the chance that debtors will not be repaid. This value
impacts the debt cost of debt and as a consequence the capital structure.
Taking advantage of the 2005 Brazilian bankruptcy law reform as an experiment,
this paper measures the impact of changes in the design of the bankruptcy law, mainly
due to the abrupt change in creditors’ priority, on ?rms’ choice of capital structure.
Intuitively, since the new bankruptcy law has improved creditors’ priority, their
expectations about recovery in insolvency states should increase. The more creditors
expect to receive in bankruptcy, the less they will require ?rms to pay in solvency, thus
reducing the cost of capital. A lower cost of debt ?nancing encourages ?rms to increase
the share of debt in their capital structure.
By estimating an econometric model (panel with ?xed effects) to measure the effect of
the changes in creditors’ priority order on ?rm-level capital structure, we ?nd an
increase of approximately 8.4 percent, on average, of the share of debt in the capital
structure. This effect is divided into increases of 3.6 and 4.8 percent in the share of short-
and long-term debt, respectively. Moreover, during the studied period, Brazil was
experiencing a period of high appreciation in its capital markets, making equity
?nancing more attractive. This feature reinforces the effect of bankruptcy reform on the
share of debt.
This result suggests that reforms of the bankruptcy law design that modify the
priority of stakeholders have a signi?cant impact on ?rms ?nancing policy. Therefore,
policy makers should keep in mind that by improving creditors’ priority, the cost of debt
will be reduced, making ?rms less credit constrained and motivating an increase in their
share of debt in the capital structure.
The remainder of the paper is organized as follows: Section II discusses the Brazilian
bankruptcy reform and its potential effects; Section III presents the empirical results;
and Section IV concludes.
II. The Brazilian bankruptcy law reform
The former legal framework for corporate insolvency in Brazil was very fragmented, with
the core of legislation for bankruptcy proceedings enacted in 1945. Despite providing
both liquidation and reorganization mechanisms to prevent or reduce the liquidation of
enterprises, in practice, the insolvency process was ineffective at maximizing asset values
and protecting creditor rights in liquidation. The bankruptcy priority rule speci?ed the
following priority order: ?rst, labor claims; second, tax claims; third, secured creditors’
claims; and ?nally, unsecured creditors’ claims (including trade credit).
The process of disposing of assets was also slow and highly ineffective, because of
court and procedural inef?ciency, lack of transparency, and the so-called problema da
sucessa˜ o, whereby tax, labor, and other liabilities were transferred to the buyer of a
liquidated asset sold in liquidation, which deteriorated the market value of an insolvent
company’s assets. In addition, the priority given to labor and tax claims had the practical
effect of eliminating any protection to other creditors. The former reorganization
procedure (called concordata) was a process that postponed debt payment only and did
not deal with ?rms’ restructuring.
On June 9, 2005, the new legislation on bankruptcy (Law 11,101/05) took effect. The
new liquidation procedure introduced six key changes. First, labor credits are limited
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to an amount equaling 150 times the minimummonthly wage[1]. Second, secured credits
are nowgiven priority over tax credits. Third, unsecured credits are given priority above
some of the tax credits. Fourth, the distressed ?rm may be sold (preferably as a whole)
before the creditors’ list is constituted, which can speed up the process and increase the
value of the bankruptcy estate. Fifth, tax, labor, and other liabilities are no longer
transferred to the buyer of an asset sold in liquidation. Finally, any new credit extended
during the reorganization process is given ?rst priority in the event of liquidation.
The ?rst two changes have had a direct impact on secured creditors’ priority. Since
under the former bankruptcy law, secured creditors came after all labor and tax claims,
the priority given to secured creditors has increased signi?cantly. The third one has
increased unsecured creditors’ priority. The fourth, ?fth, and sixth changes, in turn, are
expected to increase the value of ?rms in bankruptcy and as a consequence the amount
recovered by creditors. The more creditors expect to receive in the insolvency state, the
less they will require ?rms to pay in the solvency state, thus reducing the cost of capital.
Brazil’s new reorganization procedure was inspired by Chapter 11 in the US
bankruptcy code. Whereas the previous law did not permit any renegotiation between
the interested parties and only a few parties were entitled to recover their assets, now
managers make a sweeping proposal for recuperation that must either be accepted by
workers, secured creditors and unsecured creditors (including trade creditors) or the
distressed ?rm will be liquidated. Creditors play a more signi?cant role in the procedure
than previously, including negotiating and voting for the reorganization plan. Table I
summarizes the main changes in the Brazilian bankruptcy law.
Some data on creditors’ recovery rate will help to illustrate the main effects of the
bankruptcy law reform. Before the reform, the recovery rate in the case of bankruptcy
was a mere US$0.002 on the dollar in Brazil, while the average of Latin American and
Organization for Economic Cooperation and Development (OECD) countries was
US$0.27 and 0.66, respectively[2]. Basically, the reason for such low recovery was the
priority order, since creditors ranked behind labor and tax claims. Thus, the remaining
amount from the bankruptcy process used to pay creditors was usually insigni?cant
or nil.
New law Former law
Liquidation
Priority order
Secured
creditors
Second in the priority order: after labor
claims limited to 150 minimum monthly
wages
Third in the priority order: after labor
and tax claims
Unsecured
creditors
Fourth in the priority order: after labor,
secured creditors, and some tax claims
Fourth in the priority order: after labor,
secured creditors, and tax claims
Liabilities Tax, labor, and other liabilities are no
longer transferred to the buyer of an
asset sold in liquidation
Tax, labor, and other liabilities were
transferred to the buyer of a liquidated
property sold in liquidation
Reorganization
Postbankruptcy
credit
First to receive if the ?rm goes to
liquidation
Third to receive if the ?rm goes to
liquidation, after labor and tax claims
Role of
creditors
Creditors negotiate and vote for the
reorganization plan
None
Table I.
The main changes in the
Brazilian bankruptcy law
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As a consequence, of the bankruptcy reform, in 2006 creditors’ recovery rate increased to
US$0.12 onthe dollar inBrazil, while the average of Latin American and OECDcountries
remained stable (US$0.29 and 0.67, respectively)[3].
The effects on debt ?nancing: a simple model
The relationship between the bankruptcy design and its effects on cost of capital can
be illustrated using a simple model. Suppose that:
.
H1 – the borrowing ?rm is run by an owner/manager;
.
H2 – capital markets are competitive;
.
H3 – creditors can predict their mean pay-offs in the default state; and
.
H4 – creditors and the ?rm are risk-neutral.
We make the ?rst assumption because we are not dealing with the corporate governance
problem. The second assumption is realistic. The third rests on the view that
professional creditors have considerable experience with default, and the fourth is more
accurate when applied to ?rms than to individual persons.
The borrowing ?rm has a project that requires capital, I, which the ?rm must raise
externally. The ?rm promises to repay creditors the sum, F (where F ¼ I ð1 þ rÞ). The
project can return a value, v, where the ?rmis solvent if v $ Fand insolvent if v , F. Two
states of nature are possible in the future, one if the ?rmis solvent and the other if it is not.
The solvency and insolvency states return to the ?rm v
solv
and v
ins
, respectively,
where v
solv
$ F . v
ins
. The probability of solvency is p
solv
; the probability of insolvency
is ð1 2p
solv
Þ. This implies that the expected value of the project is
EðvÞ ¼ p
solv
v
solv
þ ð1 2p
solv
Þv
ins
. The bankruptcy system costs c to run. A
bankruptcy system can thus distribute to the creditors of an insolvent ?rm at most
the sum v
ins
2c, so the repayment to creditors is F if the ?rm is solvent and v
ins
2c if it
goes bankrupt and if creditors are the ?rst to receive in the priority rule.
Because the credit market is competitive, F is the largest sum that creditors can
demand to fund the project. For simplicity, the risk-free interest rate is assumed to be
zero, so that a borrowing ?rm’s interest rate is a function only of the riskiness of its
project and the properties of the bankruptcy system in place.
Creditors that lend I should expect to receive I in return. This expectation can be
written as follows:
I ¼ p
solv
F þ ð1 2p
solv
Þðv
ins
2cÞ
F ¼
I 2ð1 2p
solv
Þðv
ins
2cÞ
p
solv
:
If the bankruptcy law decrees, the priority of tax (t) and/or labor (l ) claims over secured
creditors’ claims, creditors will receive the maximum between the zero and
ðv
ins
2c 2l 2tÞ. Then, the ?nancing condition for creditors is:
I ¼ p
solv
F þ ð1 2p
solv
Þmaxðv
ins
2c 2l 2t; 0Þ:
Notice that creditors’ insolvency recovery may fall to zero in this situation, which would
strongly increase the cost of capital, and therefore, an improvement in creditors’ priority
raises their recovery rate, as occurred in Brazil right after the new law went into force.
Firms’ capital
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If the expected value that creditors recover in insolvency states increases (that is,
maxðv
ins
2c 2l 2t; 0Þ rises to maxðv
ins
2c 2
l; 0Þ, where
l is the labor claims limited
to 150 times the monthly minimum wage), then F declines, diminishing the interest rate
charged by creditors.
The more that creditors expect to receive in the insolvency state, the less they will
require the ?rm to repay in the solvency state. The ?rm’s interest rate is r ¼ ðF=I Þ 21,
which is increasing in F.
Denoting by v
u
ins
, c
u
and
l
u
the per-unit-of-investment (I ¼ 1) counterparts of v
ins
,
c and
l, we also have:
r ¼
ð1 2p
solv
Þ
p
solv
1 2max v
u
ins
2c
u
2
l
u
; 0
À Á Â Ã
;
which is decreasing in recovery rate in insolvency states:
P1. The priority of creditors’ claims over labor and/or tax claims decreases the
cost of capital.
Therefore, the increase in recovery rate is a natural consequence of an improvement in
creditors’ priority, as evidenced in Brazil. Figure 1, which presents the evolution in
creditors’ recovery rate, shows an abrupt increase in this rate after the reform. Since the
newlawtook effect in June 2005, all the procedures thereafter have followed the newrule,
increasing the recovery rate from¢0.2 on the dollar in 2004 to ¢12, 14 and 17 on the dollar
in 2006, 2007, and 2008, respectively.
As expectedbyP1, there was a reductioninthe cost of debt toBrazilian?rms (Figure 2).
Notice that the downward trend starts just after the Brazilian bankruptcy reform, and,
therefore, ceteris paribus, more projects tend to be ?nanced using debt instead of equity.
III. Empirical results
In this paper, we used ?rm-speci?c accounting data[4] for 389 publicly traded ?rms from
2002 to 2007[5]. We considered as ?rmshare of debt in the capital structure[6], the sumof
short-termdebt, long-termdebt, and accounts payable[7] divided by the ?rmvalue (total
debt plus market value).
We also separately analyzed the effect on the short-term debt share (short-term debt
plus accounts payable divided by the ?rm value) and long-term debt share (long-term
debt divided by ?rmvalue), used as proxies of unsecured and secured debt, respectively.
Since the priority changes differently for secured and unsecured creditors, we expect
different effects on both types of credit.
Figure 1.
Evolution of creditors’
recovery rate
Creditors’ recovery rate
0
4
8
12
16
20
2003 2004 2005 2006 2007 2008 2009
C
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Table II reports the descriptive statistics of our variable of interest (share of debt in the
capital structure). Notice that the share of debt (total, short-term, and long-term) presents
a downward trend from the period before to after the bankruptcy reform. The mean of
the share of debt went down from51 percent before the newlawto 35 percent afterward,
which means in relative terms a reduction of 31 percent of debt in the capital structure
(16 percent of 51 percent).
This downward trend is somewhat unexpected. We observe in the descriptive
statistics, for the pre- and post-bankruptcy reform period, a reduction in the share of debt,
although we expect a contrary tendency due to a reduction in the cost of capital (P1).
The explanation for this trend is the signi?cant increase of the market value of
Brazilian ?rms, and since the market value is used to measure the share of debt (total
debt divided by the ?rm value, where the ?rm value is total debt plus market value),
this increase directly affected our capital structure metric.
Figure 3 shows that the level of the Sa˜o Paulo Stock Market Index (IBOVESPA)
?uctuated between 9,000 and 25,000 points from 2002 to 2004, while it ?uctuated
between 25,000 and 65,000 points in 2005-2007. This trend encouraged ?rms to ?nance
themselves by issuing equity, reducing the portion of debt in the capital structure.
Mean SD
Before the bankruptcy law reform (2002-2004)
Total debt 0.51 0.28
Short-term debt 0.32 0.24
Long-term debt 0.19 0.19
After the bankruptcy law reform (2005-2007)
Total debt 0.35 0.26
Short-term debt 0.20 0.21
Long-term debt 0.14 0.16
All period (2002-2007)
Total debt 0.43 0.29
Short-term debt 0.26 0.23
Long-term debt 0.17 0.18
Table II.
Descriptive statistics –
share of debt
Figure 2.
Evolution of ?rms’ cost of
debt
Firms’ cost of debt
15
20
25
30
35
40
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Source: Brazilian central bank
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Thus, two important issues must be observed: ?rst, it is important to set the Sa˜o Paulo
Stock Market Index (in logs) as a control for the capital market trend in our empirical
model; second, the Brazilian economic environment provides a unique characteristic for
this research, since the reform was enacted in a period where equity ?nancing was very
attractive, reinforcing the potential impact of the bankruptcy reformon debt share in the
capital structure.
In addition, the Sa˜o Paulo Stock Exchange, we used as control variables the amount
of ?rms’ assets in thousands of Brazilian Reais[8] (logarithm) and macroeconomic data,
such as the logarithm of the real gross domestic product (GDP) in millions of Brazilian
Reais (logarithm), in?ation index[9], risk-free interest rate (SELIC and the benchmark
rate) and Brazilian global bonds in basis points. The GDP variable was used to control
our estimation for business cycles. The in?ation and the risk-free interest rates were
included to control for the trend of prices and the risk-free component of the cost of debt,
respectively, common to all ?rms, and the Brazilian Global Bonds to control for the risk
perception of investors. The data were obtained from both the Economatica and
Ipeadata databases (www.ipeadata.gov.br). Table III summarizes the descriptive
statistics of all control variables.
To estimate the impact of changes in creditors’ priority brought by the new Brazilian
bankruptcy lawon?rms’ share of debt (total, short-term, andlong-term), we useda panel
regression with cross-?rm ?xed effects, represented by the following functional form:
share_debt
it
¼ a
i
þ g
1
d_BR
t
þ GX
it
þ 1
it
: ð1Þ
The main results come fromthe bankruptcy lawreformdummy (d_BR), which assumes
zero for the pre-reformperiod (2002-2004) and one for the post-reformperiod (2005-2007).
The set of controls is represented by the vector X
it
.
The results of regression (1) reported in Table IV indicate that the bankruptcy law
reform had a signi?cant impact on the capital structure[10],[11]. Panels A-C show that
due to the bankruptcy reform, ?rms increased their share of debt by 8.4 percent, of which
3.6 percent represents short-term debt and 4.8 percent long-term debt. In relative terms,
the share of total debt went up approximately 17 percent (8.4 percent of 51 percent),
while the share of long-term debt increased 25 percent and the short-term debt only
11 percent.
This empirical result is aligned with our theoretical predictions. Intuitively, the
improvement in creditors’ priority reduces their risk of not getting repaid, making debt
Figure 3.
Sa˜o Paulo Stock Market
Index (IBOVESPA)
IBOVESPA
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
0
1
.
2
0
0
0
0
6
.
2
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.
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0
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2
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0
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0
7
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0
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7
Period
P
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Source: Economatica
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?nancing cheaper and as a consequence, motivating ?rms to resort to debt. Thus,
despite the downward trend of debt ?nancing (as seen in Table II), the bankruptcy
reform induced an increase of the share of debt in the capital structure.
But why do we observe a stronger effect on long-termdebt compared with short-term
debt? This can be explained by the difference in the change of priorities to secured
debtors and unsecured creditors. The Brazilian reform bene?ts secured creditors more
than unsecured ones because they have passed to second in priority, just after labor
claims (limited to 150 times the minimum monthly wage) (Table I).
To better understand the capital structure choice, now we explore ?rms’
heterogeneous responses to the bankruptcy reform. We study ?rms’ capital structure
choice as a function of their relative size, using total assets (logarithm) as a measure of
?rms’ size. Firms with more assets should be less sensitive to the reform since they can
?nance themselves by debt more easily using their assets as collateral.
To analyze heterogeneity, we add one term in regression (1):
share_debt
it
¼ a
i
þ g
1
d_BR
t
þ g
2
ðd_BR
t
· ASSETS
it
Þ þ GX
it
þ1
it
; ð2Þ
where the interaction of the bankruptcy reform dummy and the logarithm of ?rm
assets (d_BR· ASSETS) captures the ?rm-size effect.
Table V presents the results[10],[11]. Panels A and C show that the bankruptcy
reformprovided anincrease inthe debt portion, which is stronger for smaller ?rms, since
the interacted variable d_BR· ASSETS has a negative sign. This impact is signi?cant
for the share of total and long-term debt. However, the result is not the same for
short-term debt alone (Panel B). Since such debt does not require collateral, it is also
expected that the amount of assets should not affect unsecured debt ?nancing.
Mean SD
Before the bankruptcy law reform (2002-2004)
GDP (logarithm) 14.65 0.03
INFLATION (index) 119.00 14.69
SELIC (%) 19.07 2.93
GB (index) 910.00 338.35
IBOV (index) 15,755 4,260
ASSETS (logarithm) 13.32 2.30
After the bankruptcy law reform (2005-2007)
GDP (logarithm) 14.77 0.04
INFLATION (index) 147.93 4.10
SELIC (%) 15.50 2.90
GB (index) 216.94 108.10
IBOV (index) 40,428 12,188
ASSETS (logarithm) 13.36 2.48
All period (2002-2007)
GDP (logarithm) 14.71 0.07
INFLATION (index) 133.80 17.78
SELIC (%) 17.59 3.60
GB (index) 563.47 428.00
IBOV (index) 28,320 15,351
ASSETS (logarithm) 13.34 2.40
Table III.
Descriptive statistics –
control variables
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Figures 4 and 5 show the heterogeneous effect of the Brazilian bankruptcy law reform.
Computing the reform effect strati?ed by quartiles[12], we observe that it is stronger
for ?rms that hold lower amounts of assets.
The share of total and long-term debt increases almost 15 and 12 percent,
respectively, for the smaller ?rms, while it increases only 6 and 2 percent, respectively,
for bigger ?rms.
Therefore, we can conclude that although the change in bankruptcy law design has
had a signi?cant effect on ?rms’ ?nancing policy, it has had more relevance and bene?ts
for smaller ?rms.
IV. Conclusion
The main goal of this paper was to study the impact of changes in creditors’ priority
order on ?rms’ capital structure. To measure this effect, we took advantage of the recent
Coef?cient Robust SE p-value
Panel A: dependent variable: total debt
Intercept 21.360 22.130 0.950
d_BR 0.084 0.016 0.000
ASSETS 0.077 0.021 0.000
GDP 0.334 1.696 0.844
GB 20.008 0.010 0.392
SELIC 20.010 0.002 0.000
IBOV 20.397 0.281 0.157
Number of observations: 1,541, R
2
: 0.106, F-statistic: 74.49
Panel B: dependent variable: short-term debt
Intercept 230.80 21.56 0.153
d_BR 0.036 0.015 0.016
ASSETS 0.049 0.018 0.005
GDP 2.540 1.655 0.124
GB 20.022 0.010 0.025
SELIC 20.006 0.002 0.008
IBOV 20.678 0.278 0.015
Number of observations: 1,541, R
2
: 0.037, F-statistic: 74.44
Panel C: dependent variable: long-term debt
Intercept 29.44 20.17 0.145
d_BR 0.048 0.013 0.001
ASSETS 0.028 0.014 0.052
GDP 22.210 1.547 0.153
GB 0.014 0.010 0.128
SELIC 20.004 0.002 0.075
IBOV 0.280 0.258 0.278
Number of observations: 1,541, R
2
: 0.093, F-statistic: 11.58
Notes: This table presents the results of panel robust regressions, with ?xed effects, of the ?rms’
share of debt on bankruptcy reform variable (d_BR), which is represented by a dummy variable
codi?ed as 0 before 2005 and 1 after 2005; Panel A presents results for total debt share, while Panels B
and C present results partitioning by short- and long-term debt share; we control for the logarithm of
?rms’ assets (ASSETS) and for macroeconomic variables as the logarithm of GDP, Brazilian risk-free
interest rate (SELIC), the logarithm of Sa˜o Paulo Stock Market Index (IBOV) and Brazilian Global
Bonds in hundreds of points (GB)
Table IV.
Panel regression with
?xed effects: share of debt
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Brazilianbankruptcy lawreform, whose main change is the improvement of securedand
unsecured creditors’ priority.
Using data from ?rms’ balance-sheets and despite the trend for a fall in the share of
debt in the capital structure during 2002-2007, we found that the reform has brought an
increase of 8.4 percent, onaverage, of the debt share. This effect is divided into respective
increases of 3.6 and 4.8 percent in the short-term and long-term debt share. This is
explained by the improvement in creditors’ priority, since this reduces the chance of not
being repaid, decreasing the cost of debt and as a result motivating ?rms to resort to debt
funding.
We can also conclude that the bankruptcy law reform had a different effect on ?rms
?nancing policy depending on ?rm size, bene?ting smaller ?rms more.
Coef?cient Robust SE p-value
Panel A: dependent variable: total debt
Intercept 22.246 21.830 0.917
d_BR 0.246 0.057 0.000
d_BR
*
ASSETS 20.011 0.004 0.003
ASSETS 0.008 0.021 0.000
GDP 0.396 1.673 0.813
GB 20.009 0.009 0.344
SELIC 20.010 0.002 0.000
IBOV 20.411 0.277 0.138
Number of observations: 1,541, R
2
: 0.144, F-statistic: 69.91
Panel B: dependent variable: short-term debt
Intercept 230.588 21.594 0.157
d_BR 20.003 0.058 0.958
d_BR
*
ASSETS 0.002 0.004 0.466
ASSETS 0.047 0.018 0.009
GDP 2.530 1.658 0.127
GB 20.022 0.010 0.026
SELIC 20.006 0.002 0.008
IBOV 20.67 0.279 0.016
Number of observations: 1,541, R
2
: 0.032, F-statistic: 43.07
Panel C: dependent variable: long-term debt
Intercept 28.323 19.930 0.156
d_BR 0.250 0.051 0.000
d_BR
*
ASSETS 20.014 0.003 0.000
ASSETS 0.004 0.014 0.004
GDP 22.134 1.529 0.163
GB 0.012 0.009 0.153
SELIC 20.004 0.002 0.068
IBOV 0.263 0.256 0.303
Number of observations: 1,541, R
2
: 0.097, F-statistic: 12.89
Notes: This table presents the results of panel robust regressions, with ?xed effects, of the ?rms’
share of debt on bankruptcy reform variable (d_BR), which is represented by a dummy variable
codi?ed as 0 before 2005 and 1 after 2005; Panel A presents results for total debt share, while Panels B
and C present results partitioning by short- and long-term debt share; we control for the logarithm of
?rms’ assets (ASSETS) and for macroeconomic variables as the logarithm of GDP, Brazilian risk-free
interest rate (SELIC), the logarithm of Sa˜o Paulo Stock Market Index (IBOV) and Brazilian Global
Bonds in hundreds of points (GB)
Table V.
Panel regression with
?xed effects:
heterogeneous effect on
share of debt
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Notes
1. Brazil has a minimum monthly wage, called the sala´rio m? ´nimo, rather than a minimum
hourly wage.
2. Doing Business 2005 – World Bank.
3. Doing Business 2007 – World Bank.
4. Brazilian ?rms follow Brazilian Generally Accepted Accounting Principles in their ?nancial
reports.
5. Our study excludes all ?nancial ?rms, since the reform did not apply to them.
6. The end of the ?scal year.
7. We add accounts payable since trade credit is a relevant source of ?rms’ ?nancing (see
Love et al. (2007) and Nilsen (2002) for more details), and they were directly bene?ted by the
reform.
Figure 4.
Bankruptcy law effect on
the share of total debt
0.05
0.07
0.09
0.11
0.13
0.15
Min 0.25 0.50 0.75 Max
Assets percentile
S
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Figure 5.
Bankruptcy law effect on
the share of long-term debt
0
0.02
0.04
0.06
0.08
0.1
0.12
Min 0.25 0.50 0.75 Max
Assets percentile
S
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JFEP
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8. Brazilian Reais is the national currency.
9. Base year 2002.
10. In?ation was dropped due to multicollinearity.
11. Since the residuals in all regressions are heteroskedastic, we use robust standard errors in all
speci?cations.
12. The effect is calculated in the following way: ^ g
1
þ ^ g
2
· ASSETS
Quartile
:
References
Booth, L., Aivazian, V., Dermirguc-Kunt, A. and Maskimovic, V. (2001), “Capital structure in
developing countries”, The Journal of Finance, Vol. 56, pp. 87-130.
Love, I., Preve, L.A. and Sarria-Alende, V. (2007), “Trade credit and bank credit: evidence from
recent ?nancial crises”, Journal of Financial Economics, Vol. 83, pp. 453-69.
Modigliani, F. and Miller, M.H. (1958), “The cost of capital, corporation ?nance, and the theory of
investment”, American Economic Review, Vol. 48, pp. 261-97.
Nilsen, J.H. (2002), “Trade credit and the bank lending channel”, Journal of Money, Credit, and
Banking, Vol. 34, pp. 226-53.
Rajan, R. and Zingales, L. (1995), “What do we know about capital structure? Some evidence from
international data”, Journal of Finance, Vol. 50, pp. 1421-60.
Scott, J.H. Jr (1977), “Bankruptcy, secured debt, and optimal capital structure”, The Journal of
Finance, Vol. 32, pp. 1-19.
Titman, S. and Wessels, R. (1988), “The determinants of capital structure choice”, Journal of
Finance, Vol. 48, pp. 1-19.
About the authors
Bruno Funchal did his PhDin Economics at the Getu´lio Vargas Foundation, Brazil. He ?nished his
post-doc in Mathematical Economics at the National Institute of Pure and Applied Mathematics,
Brazil and is a Full Professor at the FUCAPEBusiness School. Bruno Funchal is the corresponding
author and can be contacted at: [email protected]
Mateus Clovis is a Master in Accounting at the FUCAPE Business School.
Firms’ capital
structure
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