Weak Creditor Rights and Insider Opportunism: Evidence from an Emerging Market

We document insider opportunism in an insolvency regime that is characterized by weak creditor rights and uses an accounting rule to determine bankruptcy eligibility. Using a unique dataset of bankrupt firms from India, we show insiders manage earnings downward before filing for bankruptcy via inventory and trade receivable accruals. A battery of robustness tests confirm accrual behavior is not merely driven by poor performance. Downward earnings management before bankruptcy filing is associated with more payment transactions to insiders post-bankruptcy. Low pre-bankruptcy accruals are associated with poor post-filing performance as well as greater loss of market value on bankruptcy announcement. Our results are consistent with insiders gaming the accounting-based entry rule to obtain bankruptcy protection and extracting private benefits from bankrupt firms. Our study highlights the importance of strong creditor rights for generating positive economic outcomes (La Porta et al. [1997]). ∗Radhakrishnan Gopalan and Xiumin Martin are from Washington University in St. Louis. Kandarp Srinivasan is from Northeastern University. They can be reached at [email protected], [email protected] and [email protected]. We thank Viral Acharya, Doug Skinner, Phil Berger, Nagapurnanda Prabhala, Jennifer Carpenter, participants at the 15th London Business School Accounting Symposium, 4th Annual Asian Bureau Finance and Economic Research (ABFER) conference, Moody’s-ICRA-NYU conference on “Developing India’s Fixed Income Markets for Sustainable Growth”, seminar participants at CAFRAL, NYU, Fordham University, Southern Methodist University and Boston College for valuable comments.