Economic elites are thought to exert political pressure over the design of contracting frameworks, seeking arrangements that benefit their interests (see Feijen and Perotti (2006) and Rajan (2006) for formal models). In that vein, Benmelech and Moskowitz (2010) show how “usury laws” were used in the settlement of state laws in the US as a way to secure the economic power of incumbent firms. Another manifestation of such discriminatory arrangements concerns access to collateral in credit transactions. To date, several European countries have security laws derived from the Napoleonic Code, which is predicated on the possessory nature of asset ownership. These laws were designed around an economic system in which land-based production and ownership took centre stage. Under the highly-formalised Napoleonic Code, assets are seen as unique, non-transferrable, and non-substitutable, and such legal fictions limit the types of security interests that can be written (see Omar (2007) and Ancel (2008)).
In underdeveloped contracting environments, financing is necessarily relationship-based, favouring large, well-established, well-connected incumbents over small, young, innovative newcomers (Rajan and Zingales (2003)). Efficient collateral regimes can reduce the problems underlying relationship-based financing, easing credit access. In our paper, we argue that a recent reform in France, Ordonnance 2006-346, uniquely informs the debate about the link between financial contracting, access to credit, and economic outcomes.
Ordonnance 2006-346 derogated the possessory nature of asset ownership in France, in existence since 1804. By doing so, the 2006 legislation allowed French firms to “control and operate” physical assets pledged to third parties. This seemingly simple statutory change significantly enlarged the menu of assets that firms could pledge in credit transactions, particularly hard movable assets used in modern business operations (e.g., tools, vehicles, machinery and equipment). In addition to expanding the set of assets that could be collateralised, the new statute allowed for security interests to be charged to more than one party, making it feasible for loans to be syndicated under multiple creditors, with multiple priority schemes, and multiple maturity structures. Notably, the reform did not introduce changes in the balance of power between contracting parties, in asset seizure options, or in the judicial system. This differentiates it from most other collateral reforms in recent years, which have favoured the notion of “strengthening creditors' rights” as a means to stimulate credit (see Lilienfeld-Toal et al. (2012), Vig (2013), and Assunçao et al. (2014) for recent examples of such reforms).
Changing the legal nature of asset ownership meant that firms were discretely endowed with “new assets” that they could pledge as collateral in debt transactions. Yet the new law did not affect all French firms equally. Long before Ordonnance 2006-346, companies located in France's financial centres had successfully lobbied for legal exceptions that allowed them to pledge cash, securities, and accounts receivables to factoring companies as collateral. Since these exceptions were not added to the Napoleonic Code, they were labelled “non-codified” security laws.
The various wrinkles in the process through which France reformed its security laws allow for unique insights in understanding the distributional and wealth effects of easing access to collateral and credit. Our baseline empirical strategy uses the observation that firms whose operations relied more intensively on hard assets should be favoured by a reform that differentially enhanced the ability to pledge that class of assets. A second layer of our strategy builds on the observation that French firms needed factoring services to pledge liquid assets.
Using a differences-test strategy, we show that firms with high utilisation of hard assets and limited access to factoring services increased their leverage ratios following the reform (intensive margin), with the fraction of “zero-leverage” firms among them dropping from 89% to 29% (extensive margin). Using contract-level data, we show that access to hard assets allowed for significant reductions in loan mark-ups and increases in loan maturities. Small, profitable, low-risk firms benefitted the most from derogating the Napoleonic code. Start-up firms registered unprecedented increases in the use of debt financing at incorporation. Department-level analysis allows us to map the effects of Ordonnance 2006-346 on credit access inequality within and across different areas of the country. The reform reached firms in rural areas, leading to a pronounced decline in the Gini index of credit concentration across France's countryside. Finally, we show that collateral regime changes bring positive real-side effects at both micro- and macro-economic levels.
Kevin Aretz is a Senior Lecturer in Finance at the Alliance Manchester Business School. Murillo Campello is a Professor of Finance at Cornell University. Maria-Teresa Marchica is also a Senior Lecturer in Finance at the Alliance Manchester Business School.