The Value of Bankruptcy Enforcement in Financial Distress: Evidence from the Chinese Bond Market

The bankruptcy process in many countries is lengthy and cumbersome, which prevents creditors from getting repaid efficiently in distress. Exploiting the staggered introduction of specialized bankruptcy courts in China, we find that they lead to sizable reductions in the cost of debt financing. In particular, bond spread represents a decrease by 7.6%, with a stronger effect on privately owned enterprises and issuers of higher default risk. By analyzing manually collected bankruptcy filings, we find court enforcement explains 43.7% of the variation in bond spreads. Exploration on the default resolution shows that the potential mechanisms are reduction in liquidations, shorter bankruptcy proceedings, less government interference, and higher creditor recovery rate. Better creditor protection translates into significant increases in debt capacity, bond maturity and investment by bond issuers. These results indicate that stronger court enforcement is a necessary precondition for firms to benefit from judicial reforms in handling the USD 120.2 billion bond defaults.