ContractsProf Blog

Editor: Myanna Dellinger
University of South Dakota School of Law

Friday, January 28, 2005

Law, institutions, and the shape of financial contracts

It’s intuitive to most of us that the law and legal institutions play a role in shaping the form of contracts.  But how, and how much, has been much more talked about than studied.

Into the breach comes a new paper from the National Bureau of Economic Research.  Finance professor Philip Strahan, in How Law and Institutions Shape Financial Contracts: The Case of Bank Loans takes a look that sounds very interesting:

We examine empirically how legal origin, creditor rights, property rights, legal formalism, and financial development affect the design of price and non-price terms of bank loans in almost 60 countries. Our results support the law and finance view that private contracts reflect differences in legal protection of creditors and the enforcement of contracts. Loans made to borrowers in countries where creditors can seize collateral in case of default are more likely to be secured, have longer maturity, and have lower interest rates. We also find evidence, however, that “Coasian” bargaining can partially offset weak legal or institutional arrangements. For example, lenders mitigate risks associated with weak property rights and government corruption by securing loans with collateral and shortening maturity. Our results also suggest that the choice of loan ownership structure affects loan contract terms.

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