Creditor rights and investment sensitivity: evidence from an emerging market

Purpose Creditor rights reduce or increase agency problems in corporations, affecting financial decisions. This study examines the impact of India’s Insolvency and Bankruptcy Code of 2016 (hereinafter referred to as the Code) on firms’ investment and investment sensitivity based on their health, considering this Code as more creditor-friendly than pre-existing bankruptcy laws. Design/methodology/approach This study uses a quasi-natural experiment that employs the difference-in-differences (DID) and propensity score matching difference-in-differences (PSM DiD) approach by considering the Code as treatment and categorizing the firms into distressed (treated group) and healthy (control group) firms. For the purpose of analysis, a fixed-effect regression model is used. Findings This study finds that distressed firms reduce their investment after the Code, but healthy firms do not observe any change. It shows that the reduction in investment of the distressed group is significantly greater than that of the healthy group due to agency conflict and the liquidation bias hypothesis. However, the reduction in investment is not followed by the change in investment sensitivity. Originality/value This study adds to the existing studies on the impact of the Insolvency and Bankruptcy Code, 2016 on investment. No study explores the relationship between this Code and investment based on the financial health of the firms. Also, none of the studies explores the impact of the Code on investment sensitivity. The results show that this Code has provided stronger protection to the creditors, which hurts the internal stakeholders’ interests. The study has implications for policymakers and academicians.