David Schoenherr - Princeton University

"The Economics of Legal Uncertainty", with Jiwon Lee and Jan Starmans

Abstract

In this paper, we examine the impact of legal uncertainty on economic activity. We develop a model that distinguishes between two types of legal uncertainty: idiosyncratic (diversifiable) and systematic (nondiversifiable), both of which can reduce economic activity. We test the model's predictions using micro-level data on bankruptcy judges and corporate loans in Korea. Exploiting random assignment of cases to judges and exogenous judge rotations in the judicial system, we compute time-varying court-level measures of debtor-friendliness and legal uncertainty as perceived by debtors and creditors. Our results show that firms tend to file for restructuring in courts with higher levels of debtor-friendliness and lower levels of legal uncertainty. We also find that higher legal uncertainty decreases the size of credit markets, predominantly for high-risk firms. Our analysis further indicates that credit supply is less sensitive to idiosyncratic sources of legal uncertainty than credit demand, as banks can better diversify idiosyncratic legal uncertainty.

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