In a recent article, entitled ‘The Capital Maintenance Regime Matters for Creditors’, we verify whether adherence to the capital maintenance regime—that is, refraining from distributing legal capital and the relative stability of the latter on the right hand side of the balance sheet—enhances firms’ ability to incur external financing with different maturities.
The debate about the economic efficiency of the capital maintenance regime and the differences between the Anglo-American and the Continental accounting system has a long history and represents one of the most controversial issues in European corporate law. Advocates of the capital maintenance regime postulate that its enforcement protects creditors from excessive distribution of equity capital and firms’ plundering (particularly in the event of major consolidations), yielding benefits similar to debt covenants, which are particularly valuable for non-adjusting creditors. Regulatory limitations also reduce the costs associated with negotiations of credit agreements and protect executives from pressure on the part of shareholders to increase payouts.
The opponents of the legal enforcement of capital maintenance rules have stated that limits to payouts and equity disbursement distort financial decision making, which may prevent economically viable transactions from taking place. While creditors are encouraged to take care of their interests by appropriately adjusting the conditions stipulated in credit agreements, the ex post constraints imposed on firms’ payout decisions should be flexible and rely on solvency tests as a key criterion for alignment between shareholders’ and creditors’ interests.
Since normative debates have failed to yield a definite answer to the problem of applying the capital maintenance regime, the growing expectation has been that investors, rather than legislators, will resolve the issue. At the same time, the theoretical arguments on the topic have been weakened by the notorious lack of relevant empirical evidence on the role of the capital maintenance regime in modern company law. Empirical studies have been silent on the importance of the capital maintenance regime for securing creditors’ rights and interests. The research gap in this domain is therefore substantial. In our article we try to fill this gap.
On the basis of empirical evidence, we show that the capital maintenance regime implemented through share capital affects lenders’ perception of credit risk and thus enterprises’ ability to raise debt. Legal capital is important for all creditors, although it is more important for non-adjusting creditors, who cannot secure their liabilities with agreements, than for adjusting creditors. This is in line with the predictions previously presented in the literature, formulated on the basis of the normative debate. We also show that the capital maintenance regime is of particular importance for lenders in companies in which the owners have limited liability. It is much less important in enterprises in which at least some of the owners have unlimited liability.
The findings reported in our article cast doubt on the arguments advanced by opponents of the capital maintenance regime, who have argued that it has ceased to fulfil its function of aligning the interests of creditors and shareholders effectively. We show that the opposite is true. We documented a persistently strong link between legal capital and the availability of external financing. Thus, strict adherence to the capital maintenance rules seems to be an effective mechanism for limiting credit risk.
Tadeusz Dudycz is a Professor of Finance at the Wrocław University of Science and Technology, Poland.
Paweł Mielcarz is a Professor of Finance at the Kozminski University, Poland.