Creditor Rights and Related-Party Transactions: Evidence from the Implementation of the Insolvency Reforms in India

• In Event: 3.02. Accounting Information and Firm Risk Assessment

Abstract

Non-arm’s-length business and personal transactions between a firm and its related parties, or related-party transactions (RPTs), are highly prevalent in emerging economies. RPTs can fulfill legitimate business needs in less developed markets. However, RPTs are often used opportunistically and reflect self-dealing by firm insiders and their related parties at the expense of external capital providers. We examine the role of a hitherto overlooked constituency in the context of RPTs – the firm’s creditors. Specifically, we investigate whether enhanced creditor rights affect RPT levels using transaction-level data from India. We use the enactment of the Insolvency and Bankruptcy Code (IBC) in 2016 as a shock to the rights of certain creditors. The IBC affected financial and operational creditors differently. While IBC significantly enhanced financial creditor rights, operational creditors (such as employees and suppliers) do not have a vote in the decision-making process. As a result, we expect IBC to impact financing and operating RPTs in different ways. Consistent with stronger creditor rights deterring opportunistic RPTs and making arms-length external financing more attractive, we find that firms with greater reliance on unsecured credit (i.e., the treatment firms) reduce their reliance on RPTs following the implementation of IBC. In contrast, consistent with arms-length operational creditors being disadvantaged by IBC (relative to financial creditors), we observe a significant increase in the use of operating RPTs. Cross-sectional analyses suggest that the effects of creditor rights are muted in presence of strong corporate governance. Our findings are robust to the inclusion of firm fixed effects and Propensity-Score Matching.

Authors

• Ole-Kristian Hope, University of Toronto - Rotman School of Management

• Christine Liu, University of Toronto

• Dushyantkumar Vyas, University of Toronto - Rotman School of Management