Does bankruptcy law improve the fate of distressed firms? The role of credit channels

• Published in: Journal of corporate finance (Amsterdam, Netherlands) Netherlands), 2021-06, Vol.68, p.101836, Article 101836
• Main Authors: Bose, Udichibarna, Filomeni, Stefano, Mallick, Sushanta
• Format: Article
• Language: English
• Subjects: Bankruptcy law; Cost of debt; Debt structure; Distressed firms; Firm performance
• ISSN: 0929-1199; 1872-6313
• DOI: 10.1016/j.jcorpfin.2020.101836

Growing financial failure at firm-level can have serious consequences for banks in terms of rising non-performing assets, in the absence of a strong bankruptcy system. Such a scenario in India made its dysfunctional insolvency system to be reformed, introducing the new Insolvency and Bankruptcy Code (IBC) in 2016. Using a panel of 33,845 Indian firms over the period of 2008–2019 and by employing a difference-in-differences approach, we investigate how the IBC has supported financially distressed firms in mitigating their intrinsic vulnerability during the post-IBC period, compared to their non-distressed counterparts. We find that through expanded credit availability and lower cost of debt financing during the post-IBC period, distressed firms are able to improve their performance relative to non-distressed firms. Furthermore, we provide evidence that the benefits stemming from the implementation of the IBC policy are more prominent for those financially distressed firms that are larger, younger and more collateralized. Our results are robust to a battery of tests and identification strategies. Our conclusions are relevant in contributing to the current academic and policy debates on safeguarding and preserving business performance and continuity under stressed scenarios. •We analyse the impact of a new bankruptcy law on performance of distressed firms.•We use a dataset of 33,845 Indian firms over the period 2008–2019 within a difference-in-differences setting.•Distressed firms are better-off relative to non-distressed firms as a result of the legal intervention.•The channels work through an expanded credit availability and a lower cost of debt financing.•The benefits are more prominent for those distressed firms that are larger, younger and more collateralized.