The Balance of Power between Creditors and the Firm: Evidence from German Insolvency Law

In late 2011, German legislators passed the latest reform to German Insolvency Law (ESUG). ESUG mandates that creditors of larger firms can exert more influence on the appointment of the insolvency administrator, resulting in a shift of power from shareholders to creditors. Based on difference-in-differences estimation, we find that larger firms reduced financial leverage around this event, while firms below the size threshold of the law increased debt levels. Furthermore, after the enactment of ESUG, larger firms spend less money on investment, while smaller firms invest more and benefit from lower cost of debt. Overall, the evidence is consistent with the view that, in an environment where creditors are already well protected, even stronger creditor protection does not necessarily foster borrowing.