Legal enviroment and firm crisis: some evidence from the cross-border insolvency of the Italian foreign-owned firms

The issue of whether foreign-owned firms (FOFs) are more likely to exit the market than domestic firms (DOMFs) is highly debated in the political as well as in the academic field. The “footloose” character of multinational enterprises is justified by the fact that, as part of an international production network, these firms can easily relocate production between countries in response to adverse shocks in the host country or to changes in local costs. Through the optimal portfolio theory U.S. multinationals were shown to rapidly adjust their operations to changes in host country environments based on particular country risks. The higher propensity to exit the market for FOFs might also be linked to the type of international production: if international production is horizontal – where multinational enterprises duplicate their home country-based activities at the same value chain stage as in the host-country – then FOFs may be less likely to close plants since they serve a target market. Conversely, when multinational enterprises undertake vertical international production - which occurs when different stages of production are located in different countries - they might be more likely to close and relocate their plants as they are more sensitive to changes in costs of production. The empirical evidence has produced ambiguous results. A large amount of empirical research found that FOFs are more footloose than DOMFs, whereas other studies found that they have the same survival chances as DOMFs. It is worth noting that this literature presents two main shortcomings. First, it often associates a firm’s death to the termination of the firm’s activities; in other words, a firm that is in liquidation, dissolved, or in receivership is defined as inactive. However, the hypothesis of considering a firm in crisis as an insolvent firm is relatively strong mainly during an economic slowdown. The notion of crisis is broad and encompasses different degrees of economic and financial distress or difficulties, for some of which there is an actual chance of reversal if tackled with adequate means. In addition, in these studies not much attention has been given to the role of the legal system (i.e., the set of legal rules that govern the life of a community within a specific environment where firms operate. In particular, the part of the legal system we are considering basically refers to firm crisis law, rescue of business assets and creditors’ rights and protection. It is to be expected that country-specific differences in cross-border insolvency legal rules might affect the pattern of firms’ death and survival through corporate restructuring and bailout. At the onset of the state of crisis, foreign firms might move their centre of main interests (COMI) to those countries with a legal system that they consider to be more liberal and in which there is less conditioning and better prospects for reorganisation and rescue. From the literature of new institutional economics, it is well known that firms’ behaviour is strongly affected by the institutional framework where they operate. In particular, when analysing the impact of corporate bankruptcy laws on the level of firm growth, some scholars found that rendering bankruptcy laws more entrepreneur-friendly might stimulate a larger number of entrepreneurs to startup firms. Moreover, Armour and Cumming find that entrepreneur-friendly bankruptcy laws enhance entrepreneurial demand for venture capital that funds risky ventures. In a nutshell, our study addresses some important yet underexplored questions: What is the relationship between multinational status and firm death rates? How can the cross-border insolvency legal rules produce firms’ death or survival through corporate restructuring and bailout? To this end, we apply survival methods and estimate a discrete-time hazard model in which we look for the effect of foreign ownership on firm death and crisis, controlling for firm- and industry-specific covariates. We endeavor to contribute to the empirical literature on firm death and survival in several ways. First, our analysis is based on a very large dataset with a wide coverage of the firm universe in Italy. Second, unlike most of the empirical literature, our study does not associate the firm’s death with the termination of the firm’s activities but focuses on a notion of firm crisis that distinguishes the situation of firms’ economic and financial upheaval from the inability to regularly fulfil their obligations. Finally, it addresses how country-specific differences in cross-border insolvency legal rules might affect the pattern of firms’ death and survival. The paper is organised as follows. Section 2 provides a description of the European regulatory systems on cross-border insolvency. Section 3 describes the data and presents the statistical model used in the paper. Section 4 shows the main results of the empirical analysis and, finally, Section 5 summarises and concludes.