The impact of institutional performance on payment dynamics: Evidence from the Italian manufacturing industry

Falavigna, Greta; Ippoliti, R. Article The impact of institutional performance on payment dynamics: Evidence from the Italian manufacturing industry Journal of Business Economics and Management (JBEM) Provided in Cooperation with: Vilnius Gediminas Technical University (VILNIUS TECH) Suggested Citation: Falavigna, Greta; Ippoliti, R. (2020) : The impact of institutional performance on payment dynamics: Evidence from the Italian manufacturing industry, Journal of Business Economics and Management (JBEM), ISSN 2029-4433, Vilnius Gediminas Technical University, Vilnius, Vol. 21, Iss. 5, pp. 1285-1306, https://doi.org/10.3846/jbem.2020.13195 This Version is available at: https://hdl.handle.net/10419/317434 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. 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Published by VGTU Press *Corresponding author. E-mail: [email protected] This is an Open Access article distributed under the terms of the Creative Commons Attribution License (http://creativecommons. org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided the original author and source are credited. Journal of Business Economics and Management ISSN 1611-1699 / eISSN 2029-4433 2020 Volume 21 Issue 5: 1285–1306 https://doi.org/10.3846/jbem.2020.13195 THE IMPACT OF INSTITUTIONAL PERFORMANCE ON PAYMENT DYNAMICS: EVIDENCE FROM THE ITALIAN MANUFACTURING INDUSTRY Greta FALAVIGNA 1, Roberto IPPOLITI 2* 1Research Institute on Sustainable Economic Growth, CNR, Moncalieri, Italy 2Faculty of Business Administration and Economics, Bielefeld University, Bielefeld, Germany Received 03 January 2020; accepted 03 June 2020 Abstract. This work aims to shed new light on the relation between institutional performance and firm dynamics. Considering the Italian manufacturing industry and a panel of 3 years, the authors investigate the relation between the time needed by courts to enforce debtors’ obligations and the time needed by enterprises to repay their debts. In particular, we test the hypothesis that efficiency in settling mortgage foreclosure and bankruptcy cases can affect the creditors’ decision making on judicial disputes. According to our thesis, inordinately long waiting times to enforce credit rights may increase the contractual strength of debtors, further delaying payments. As shown by our results, there is a statistically significant positive relation between the enforcement of debtors’ obligations and the adopted payment index, confirming the key role of the judiciary in the dynamics of firms. Indeed, if the time needed to settle bankruptcy cases decreases by 25%, we can expect the payment index to decrease by 1%; while, focusing on foreclosure cases, we can expect the payment index to decrease by 2%. The policy implications of these results are rather compelling. Policy makers could reform foreclosure and bankruptcy procedures to support national economic growth, without additional burden on the public budget. Keywords: manufacture industry, payment dynamics, institutional performance, strategic management, judicial efficiency, insolvency procedures. JEL Classification: K12, G33. Introduction The risk of business failure is a relevant topic, with significant effects on the market and society. On the one hand, creditors’ rights need to be defended against debtors’ insolvency while, on the other hand, the national economic system needs to be supported and its reputation protected on the global market. Accordingly, the literature has focused on this topic, prompting academics and institutions to investigate bankruptcy and to propose new models that can 1286 G. Falavigna, R. Ippoliti. The impact of institutional performance on payment dynamics: evidence... predict enterprises’ default with an even higher level of accuracy (Becchetti & Sierra, 2003). The effective use of screening models can significantly reduce information asymmetries between borrowers and lenders, enhancing the efficiency of the financial intermediation process (Psillaki etal., 2010). Moreover, improvements in screening and monitoring techniques are a valuable alternative to incomplete contracts, reducing moral hazard and adverse selection problems (Stiglitz & Weiss, 1981, 1992). However, all these efforts are fruitless without an appropriate institutional environment, able to support the enforcement of contractual obligations. Grossman and Hart (1986), Hart and Moore (1990), and Hart (1995) suggest that contracts are incomplete if the institutional environment is not efficient, that is to say, contracts are incomplete if they cannot be fully enforced due to the poor quality of institutions. Hence, the quality of institutions might act as a disincentive for firms or industries, which require relationship-specific investments (Chakraborty, 2016). The economic implications of this hypothesis are relevant, as documented in the current literature. Levchenko (2007) and Nunn (2007) show that better institutional quality tends to increase a country’s exports, while Berkowitz etal. (2006) and Ranjan and Lee (2007) highlight that countries with better contract enforcement have comparative advantages in highly differentiated final products. Focusing on a reform aimed at facilitating the speedy disposal of civil lawsuits, Chemin (2010) finds that an efficient institutional environment leads to fewer breaches of contract, encouraging investments and facilitating access to the financial market. Antràs (2003, 2005) provides further theoretical guidance on the micro effects of institutions, and suggests that contract enforcement can shape the business decisions and trade structures of multinational companies. Starting from this background, our work aims to shed new light on forms of opportunistic behavior and strategic decision making that may arise in case of institutional inefficiency, causing one of the parties to adopt alternative forms of resolution and the other to increase its contractual strength. In particular, we expect a creditor to be able to collect due sums of money in case of debtor’s insolvency based on how efficient courts are in enforcing credit rights. Judicial inefficiency can discourage creditors from requesting mortgage foreclosure and/or a declaration of bankruptcy, decreasing the opportunity cost of Alternative (nonjudicial) forms of Dispute Resolution (ADR), i.e., those processes that involve third parties providing conciliation and/or mediation (e.g., the State or even private facilitators) and assisting in the settlement of conflicts, but without any binding determination (Hann etal., 2019). Even more importantly, this inefficiency can increase debtors’ contractual strength and, as a result, affect firm dynamics and the structure of markets. This is the main hypothesis put forward in this work and its main contribution to the current literature. The remainder of this article is organized as follows. The first section presents an overview of the literature on judicial efficiency and its impact on economic growth and company dynamics. Then, based on the proposed background, we introduce our hypothesis regarding the expected impact of judicial inefficiency on contractual obligations. The second section illustrates the case study (i.e., the Italian manufacturing industry) and the methodology adopted to test the above hypothesis, as well as the functioning of the Italian procedures in case of insolvency (i.e., mortgage foreclosure and bankruptcy). Finally, the third section deals Journal of Business Economics and Management, 2020, 21(5): 1285–1306 1287 with the results of the empirical analysis, while the last section describes the conclusions of our research. 1. Theoretical background: judicial efficiency and company dynamics The current literature suggests that judicial efficiency has a positive impact on economic growth (Chemin, 2009), influencing both firm dynamics (e.g., Johnson etal., 2002; Dougherty, 2014; Lichand & Soares, 2014; Falavigna etal., 2019) and the financial markets (e.g., Djankov etal., 2008; Qian & Strahan, 2007; Ponticelli & Alencar, 2016). Consequently, there is a great need to improve the supply of justice, by correctly assessing the performance of the courts and of the judicial system as a whole (e.g., Falavigna etal., 2018; Silva, 2018; Mattsson & Tidanå, 2019; Agrell etal., 2020; Ippoliti & Tria, 2020). According to Hayo and Voigt (2013), judicial procedures can positively affect a country’s economic growth, suggesting that some procedural devices can improve a state’s capacity to credibly commit to the promises contained in its laws. Moreover, Hayo and Voigt (2013) argue that, by making judicial decision more transparent and judges more accountable to the law, more trade and investments are expected to take place, which will, in turn, be reflected in higher rates of economic growth. Giacomelli and Menon (2017) show that poor contract enforcement can affect firms’ incentives to grow, confirming the evidence collected by Fabbri (2010), and their results suggest that reducing the length of judicial proceedings by 10% leads to a 2% increase in the average size of local firms. Wang etal. (2014) assert that judicial quality can affect firms’ exports through its efficiency in settling business contract disputes. In particular, focusing on the Chinese market, they conclude that firms in regions with better judicial quality will have a comparative advantage in exporting goods, thanks to cost saving from an efficient dispute settlement system. Looking at the Indian market, Chakraborty (2016) collects similar results, confirming that judicial quality is a significant determinant of higher firm performance in terms of both exports and domestic sales. More precisely, Chakraborty (2016) estimates that a 10% increase in judicial quality leads to a 1–2% increase in sales by local firms. Taking the financial markets into account, Laeven and Majnoni (2005) find that judicial efficiency is one of the main drivers of interest rate spreads, implying that improvements in judicial enforcement of contracts are critical to lowering the cost of financial intermediation for households and firms. In addition, Bae and Goyal (2009) show that banks respond to poor enforceability of contracts by reducing loan amounts, shortening loan maturities, and increasing loan spreads. In a recent article, Shah etal. (2017) investigate the relation between credit rights and judicial efficiency, as well as its influence on firms’ corporate leverage. Their results point to the fact that improved efficiency in enforcing these rights makes credit more readily available, due to greater loan supply. Focusing on the enforcement of insolvency cases (i.e., bankruptcy), Shah and Shah (2016) analyze the relationship between national judicial efficiency and the cash holdings of corporations. They argue that efficient judicial systems are associated with higher levels of corporate cash holdings, supporting what they call the managerial-fear hypothesis. According to this hypothesis, managers believe that improvements in judicial efficiency can increase the probability of bankruptcy and loss of their 1288 G. Falavigna, R. Ippoliti. The impact of institutional performance on payment dynamics: evidence... jobs, and they respond to this fear by hoarding extra cash as a buffer against such negative outcomes. Drawing on the seminal work by Modigliani and Miller (1958), Falavigna and Ippoliti (2018) gather similar evidence on opportunistic behavior, concluding that the higher the judicial inefficiency in enforcing creditors’ rights, the higher the risks taken by managers and/or stockholders, due to the perceived lower likelihood of creditors requesting a declaration of bankruptcy. Investigating the legal consequences expected by entrepreneurs in case of insolvency, Armour and Cumming (2008) obtain, once again, similar results, showing that the relaxation of bankruptcy laws can promote entrepreneurship, since (private) failure risks and related social costs are more limited. Against this background, we explore the efficiency of courts in enforcing creditors’ rights and how this affects the performance of firms and their strategies. More precisely, considering the Italian judicial system and its laws, we investigate the relation between enforcement of creditors’ rights and debtors’ payments. Djankov etal. (2007) assess the enforcement of creditors’ rights against defaulting debtors by constructing an aggregate index, with score between zero (poor creditors’ rights) and four (strong creditors’ rights). In particular, this creditor index takes four measures into account: whether secured creditors are able to seize their collateral once a reorganization petition is approved (i.e., whether the court imposes an “automatic stay” on assets); whether restrictions must be observed when a debtor files for reorganization (e.g., creditor consent), as opposed to debtors seeking unilateral protection from creditors’ claims by filing for rehabilitation; whether secured creditors are paid first out of the proceeds from liquidating a bankrupt firm or whether third-party claims take priority; and whether creditors or an administrator are responsible for running the business during reorganization, rather than having the debtor continue to manage the business. This index clearly represents the creditors’ difficulties in collecting the sums of money due. Another key proxy could be the time required to settle a case of insolvency, which, if particularly long, is likely to discourage creditors from taking legal action against the insolvent debtors, ultimately leading them to search for alternative approaches. In the case of the Italian judicial system and its bankruptcy procedure, creditors may well wait for years before obtaining the enforcement of their rights (Rodano etal., 2016; Falavigna & Ippoliti, 2018), and they can expect a low level of enforcement adaptability due to the country’s legal origin (Beck & Demirguc-Kunt, 2005)1. This result is even more significant in view of the fact that Italian businesses are not secured creditors, i.e., there are other parties that have priority in the reimbursement process (e.g., employees). In other words, considering the Italian market, there is no certainty in insolvency applications and the efficiency of the courts in enforcing bankruptcy laws may be a crucial determinant in shaping creditors’ strategies. Focusing on Spain, France and the United Kingdom, García-Posada and MoraSanguinetti (2013) collect similar results, suggesting that bankruptcy law has little influence on financial distress affecting small firms, since bankruptcy procedures are costlier and longer than the main alternative judicial procedure (i.e., mortgage foreclosure). Yet, what could happen if the alternative judicial procedure for dispute resolution is also inefficient? Is an 1 According to Beck and Demirguc-Kunt (2005), French legal origin countries (e.g., Italy) have low levels of enforcement adaptability, since their judiciaries are less independent from the government than in countries with common law tradition, as well as less likely to embrace jurisprudence and base judicial decisions on principles of equity. Journal of Business Economics and Management, 2020, 21(5): 1285–1306 1289 inefficient form of judicial dispute resolution (e.g., insolvency application and/or mortgage foreclosure) the best option for a creditor? Is it admissible to hypothesize that a creditor might prefer to search for alternative (non-judicial) means of dispute resolution? Moreover, is it admissible to hypothesize that a creditor might prefer to wait a few extra months to obtain the sums due (i.e., postponing the payment deadline) and avoid the related additional legal costs, rather than having to wait a few extra years for a lower and uncertain payment? Based on these key questions, we introduce our main hypothesis: the performance of courts can shape the creditors’, as well as the debtors’, decision-making processes on judicial dispute resolution. On the one hand, the debtors can deliberately decide to postpone the payment deadline, substituting unsecured debt financing with supplier financing, since the institutional system is not able to guarantee the enforcement of suppliers’ rights, at least not in the short run. Indeed, a solvent debtor may be unwilling to repay if the gain from insolvency is greater than the perceived cost of potential sanctions, which depends mainly on the entire set of institutional arrangements governing the credit market, as well as on its enforcement by the judiciary (Jappelli etal., 2005). On the other hand, the creditors have no other option but to search for alternative (non-judicial) means of dispute resolution, which might have unpredictable results, and to keep waiting for their money, thus increasing the debtors’ contractual strength. In view of all of the above, we propose the following primary hypothesis: H1 judicial inefficiency in enforcing credit rights can cause payment deadlines to be postponed, supporting the substitution of unsecured debt financing with supplier financing. Current data can help us establish whether this opportunistic behavior actually exists, testing the expected positive relation between the time needed to settle a case of insolvency (i.e., mortgage foreclosure and bankruptcy) and an estimated index that is representative of payment times. If the proposed hypothesis is confirmed, the economic implications of this negative externality could be far-reaching for the whole economy, decreasing the competitiveness of the national system and triggering a cascade effect on the market. This may be even truer in the Italian market, with its characteristic structure based mostly on smallmedium enterprises (SMEs). 2. Methodology and data In order to examine the proposed hypothesis, we focus on a specific case study, i.e., the Italian judiciary and manufacturing industry. On the one hand, the Italian judicial system is one of the worst in the European Union in terms of inefficiency in settling civil and penal cases (CEPEJ, 2016). On the other hand, the Italian manufacturing industry is one of the most important in Europe, with exports to third countries worth billions. This set of circumstances provides the opportunity for an interesting case study, which can shed new light on the relation between contract enforcement and firm dynamics. Our empirical strategy relies on two key time variables: the time needed by a court to settle a judicial case of insolvency (i.e., legal period, for both mortgage foreclosure and bankruptcy) and a representative proxy for the time needed by a firm to pay a debt (i.e., payment period). Controlling for some selected external and internal variables, we test hypothesis H1 1290 G. Falavigna, R. Ippoliti. The impact of institutional performance on payment dynamics: evidence... to determine whether a statistically significant positive relation between these two key time variables might exist. To do this, financial and economic information on the Italian manufacturing industry and its enterprises (our observations) is drawn from an international database (i.e., Bureau van Dijk). After thorough pre-processing of this information, data about external conditions are extracted from national databases (i.e., Ministry of Justice and Italian Institute of Statistics), and assigned to every observation as key environmental variable. 2.1. Preprocessing phase and outlier detection For each enterprise, financial and economic information is extracted from the annual accounts included in the AIDA database (Source: Bureau van Dijk)2. This type of data might suffer from inaccuracies due to the digital scanning of the documentation; accordingly, preliminary checks are performed taking some simple rules for the drafting of financial statements into account. For example, we exclude firms with different values in total assets and total liabilities, negative values in debts, credits, cash, share capital, reserves, and so on. Moreover, following the current literature (Bay etal., 2006; Schreyer etal., 2017), we apply the simple measure of the Euclidean norm of annual accounts in order to detect and remove anomalous data (Filzmoser etal., 2008). The proposed methodology may be thought of as a cluster analysis in which observations in the tails of the distribution are considered outliers and, consequently, dropped from the statistical analysis (Soltanolkotabi & Candes, 2012). In detail, for each firm the Euclidean norm is computed as: 222 1 1 , J Jj j xv v v = = +…+ = ∑ (1) where x is a vector representing the annual accounts values used in the empirical analysis of the firm under observation, and v1, …, vj, are elements of vector x (e.g., x = (trade receivables, cash, sales,…)). Once the norm for each firm is obtained, we look at the Median Absolute Deviation (MAD) to detect and then drop the outliers (Leys etal., 2013; Huber, 1981). In addition, we perform the computation of the median (M) considering three stratifications: year, industry, and size3. As suggested by Miller (1991), the rule for cutting the tails of the distribution is: 3 3 . 3 . xM M MAD x M MADor MAD − − <+ ± (2) After the application of this methodology, the number of observations is reduced by 8.65%. Table1 shows the number of observations before and after outlier detection. Note 2 The annual accounts of Italian businesses are based on the Fourth Council Directive of 25 July 1978 (78/660/EEC) and its following amending acts (see https://eur-lex.europa.eu). This financial and economic information is more detailed than that required by the International Accounting Standards (IAS), providing the opportunity for a very interesting case study. 3 This work adopts the criteria for size classification suggested by the current legislation (Recommendation 2003/361/EC and Decreto del Ministro dello Sviluppo economico del 18 aprile 2005). Accordingly, if Total Assets are under 2,000,000€/year, the firms are “Micro”; if Total Assets are between 2,000,000€/year and 10,000,000€/year, the firms are “Small”; if Total Assets are between 10,000,000€/year and 43,000,000€/year, the firms are “Medium”; and finally, if Total Assets exceed 43,000,000€/year, the firms are “Big”. Journal of Business Economics and Management, 2020, 21(5): 1285–1306 1291 that the final number of observations is determined by the available information. For this reason, the numbers indicated in the empirical models (Tables5, 6 and 7) are lower than those proposed in Table1, which does not exclude the observations with missing values and payment time equal to zero. Table 1. Sample size before and after outlier detection (Italy, 2014–2016) 2014 2015 2016 Total Before MAD 95,151 99,429 88,362 282,942 After MAD 86,529 90,501 81,439 258,469 2.2. Payment times In line with the main goal of the article, the key variable in our analysis is the time needed by companies to pay off their debts. Since annual accounts only report economic flows and stocks, this information is not directly available and has to be estimated by means of indexes usually adopted in this sort of analysis. The current economic literature suggests using the Cash Conversion Cycle (CCC) indexes, which prove useful in estimating the duration of the whole production period, starting from the purchase of raw materials to the cashing of revenues from sales (Wang, 2019). In particular, we focus on a specific type of CCC: the number of days needed to repay operating debts, considering the relationship between such operating debts and operating costs in a year (Hiller etal., 2013; Fraquelli etal., 2002; Enqvist etal., 2014; Jose etal., 1996). Let v1 be the total amount payable to suppliers, v2 the cost of raw materials, consumables, and goods, v3 the cost of services, and v4 the cost of use of third-party assets. The payment index is estimated as follows: 11 234 234 360. 360 vv Payment time vvv vvv = = × ++ ++ (3) The result is multiplied by 360, as a business usually runs operations for about 360 days a year. In this way, the payment index is estimated in days as unit of measurement, representing a proxy for the time needed to repay operating debts. According to the proposed approach, this index is the ratio between a stock variable (extracted from balance sheets) and the sum of flow accounts (extracted from income statements). Specifically, in the denominator, the total cost borne during the year is divided by the number of operating days (360), representing the amount of cost per day (€/days). The numerator refers to the total amount payable to suppliers at the end of the year, which does not represent the value of debt contracted during the year but the amount of debt still to be covered (€). In light of the previous discussion, although it does not correspond to the real number of days of delay, the suggested index can be regarded as a proxy for delay in paying operating payables. Moreover, this index may represent varying degrees of reliance on debt financing, i.e., the results of the empirical analysis may be interpreted as indicating that debtors rely more on debt to finance operating costs when judicial enforcement is weaker. 1292 G. Falavigna, R. Ippoliti. The impact of institutional performance on payment dynamics: evidence... Table2 presents some preliminary descriptive statistics, showing the payment index by geographical macro areas (NUTS1). It emerges from the results that the estimated time needed to repay operating debts increases dramatically moving from the North to the South of Italy. Table 2. Average payment index by geographical macro areas. Analysis of the whole manufacturing industry (i.e., sample of observations: after MAD) – Italy, 2014–2016 Geographical macro area 2014 2015 2016 North West 188 186 169 North East 178 180 165 Center 190 190 162 South 255 249 238 Islands 276 282 254 This estimated payment index is the dependent variable of the empirical analysis in this work. Based on the proposed hypothesis, H1, we can expect a positive relation between this estimation (i.e., the time needed to repay an operating debt) and judicial performance (i.e., the time needed to settle a judicial dispute in case of insolvency). 2.3. Legal times According to the Italian law, there are two formal procedures to settle an insolvency case (Stanghellini, 2008; Rodano etal., 2016). The creditors can either initiate a process of mortgage foreclosure (i.e., esecuzione forzata), which can target the debtors’ movables or real estate, or apply to certify the debtor’s insolvency (i.e., istanza di fallimento); after this preliminary step, the court will enforce their credit rights through a bankruptcy procedure (i.e., fallimento)4. Moreover, the debtor can apply for an arrangement with creditors through the mediation of the court (i.e., concordato preventivo). Obviously, in the latter case, the creditors cannot expect to fully recover the amounts due, but the defaulting debtor may be expected to cooperate. Under the Italian law, all creditors can engage in a mortgage foreclosure procedure, that is to say, all secured and unsecured credits can be enforced by courts through mortgage foreclosure of debtors’ goods (i.e., movable and/or real estate). The main difference between secured and unsecured credits revolves around the goods involved in the insolvency procedure. In the former situation, there is a specific good that represents the collateral in case of insolvency with respect to that specific secured credit, which cannot be involved by other creditors in other insolvency procedures (i.e., there is an exclusive right to use that good as collateral for a single secured credit). In the latter situation, there are no specific guarantees for unsecured credits, i.e., all the remaining debtors’ goods that do not represent a collateral for a secured credit can be involved in the insolvency procedure to collect the due amount of money. In 4 Note that either the debtors themselves or the prosecutors can initiate this procedure (see Legislative Decree no.169/2007). Journal of Business Economics and Management, 2020, 21(5): 1285–1306 1299 (Model 1) (Model 2) (Model 3) (Model 4) (Model 5) VARIABLES Payment index ψ Payment index ψ Payment index ψ Payment index ψ Payment index ψ Working capital –0.000620*** –0.000699*** –0.000700*** (6.14e-06) (6.38e-06) (6.38e-06) Private limited company –0.0699*** –0.0703*** (0.0185) (0.0185) Public limited company –0.507*** –0.506*** (0.0225) (0.0225) Innovative startup company 0.434*** (0.0552) Innovative small business 0.0180 (0.0824) Constant 4.202*** 4.180*** 4.223*** 4.330*** 4.325*** (0.102) (0.103) (0.101) (0.102) (0.102) Observations 252,116 252,116 252,116 252,115 252,115 R-squared 0.016 0.017 0.059 0.065 0.065 NACE codes at level 1 (FE) No Yes Yes Yes Yes Note: *** p < 0.01, ** p < 0.05, * p < 0.1. Table 7. Multiple regression models, pooled sample with robust standard errors. Analysis of the manufacturing industry without outliers (i.e., sample of observations after MAD and payment index > 0), considering bankruptcy – Italy, 2014–2016 (Model 1) (Model 2) (Model 3) (Model 4) (Model 5) VARIABLES Payment index ψ Payment index ψ Payment index ψ Payment index ψ Payment index ψ Bankruptcy time ψ 0.0406*** 0.0424*** 0.0371*** 0.0353*** 0.0354*** (0.00911) (0.00914) (0.00889) (0.00888) (0.00887) 2015 0.000690 0.000802 0.00160 0.000251 –0.000111 (0.00787) (0.00787) (0.00772) (0.00770) (0.00770) 2016 –0.209*** –0.208*** –0.202*** –0.201*** –0.202*** (0.00833) (0.00833) (0.00811) (0.00809) (0.00809) North West –0.335*** –0.327*** –0.368*** –0.346*** –0.345*** (0.0124) (0.0126) (0.0124) (0.0124) (0.0124) North East –0.379*** –0.373*** –0.426*** –0.407*** –0.407*** (0.0136) (0.0138) (0.0136) (0.0135) (0.0135) Center –0.359*** –0.346*** –0.345*** –0.333*** –0.333*** (0.0130) (0.0131) (0.0129) (0.0129) (0.0129) End of Table 6 1300 G. Falavigna, R. Ippoliti. The impact of institutional performance on payment dynamics: evidence... (Model 1) (Model 2) (Model 3) (Model 4) (Model 5) VARIABLES Payment index ψ Payment index ψ Payment index ψ Payment index ψ Payment index ψ Islands 0.149*** 0.138*** 0.142*** 0.138*** 0.138*** (0.0207) (0.0207) (0.0206) (0.0206) (0.0206) Working capital –0.000625*** –0.000704*** –0.000704*** (6.35e-06) (6.62e-06) (6.61e-06) Private limited company –0.0399* –0.0403* (0.0224) (0.0224) Public limited company –0.466*** –0.466*** (0.0258) (0.0258) Innovative startup company 0.432*** (0.0865) Innovative small business –0.0448 (0.0915) Constant 4.450*** 4.454*** 4.410*** 4.484*** 4.483*** (0.0750) (0.0759) (0.0739) (0.0764) (0.0764) Observations 219,856 219,856 219,856 219,856 219,856 R-squared 0.014 0.014 0.060 0.065 0.065 NACE codes at level 1 (FE) No Yes Yes Yes Yes Note: *** p < 0.01, ** p < 0.05, * p < 0.1. Accordingly, we cannot reject the hypothesis of a significant relation between judicial inefficiency and debtors’ contractual strength, and Figure1 validates these results even more, as it highlights the substitution of unsecured debt financing with supplier financing, depending on judicial inefficiency (i.e., bankruptcy). Taking 2016 into account and court districts as observations (adopting the number of firms as weight), the figure plots the time needed to enforce credit rights and the percentage of unsecured debt over the total amount of debt, showing a negative statistically significant relation between these two variables (p-value <0.01). In other words, the higher the judicial inefficiency, the higher the substitution of alternative financing by debtors. The other results are quite interesting, too. Examining the macro areas, we can observe that companies located in the North of Italy (i.e., North West and North East) and in the Center tend to delay payments less than those in the South of Italy (i.e., South and Islands). These statistically significant results (i.e., p-value <0.01) are coherent with the current literature on heterogeneity among Italian geographical macro-areas. As for the year variable, only 2016 is statistically significant (i.e., p-value <0.01), indicating shorter delays in that year. Coherent results are also found for working capital. All coefficients are negative and statistically significant (i.e., p-value <0.01), suggesting that an increase in working capital means End of Table 7 Journal of Business Economics and Management, 2020, 21(5): 1285–1306 1301 that firms have financial resources that they use to repay their debts. So, based on our results, if the solvability of firms increases, payment times grow shorter. In other words, companies with better working capital will be characterized by lower payment index. Finally, public limited companies are more virtuous in payments than the other legal forms (i.e., general partnership or private limited company), while being an innovative start up negatively affects the time needed to repay debts. Figure1. Substitution of unsecured debt financing with supplier financing. Analysis of the manufacturing industry without outliers (i.e., sample of observations after MAD and payment index > 0), considering bankruptcy – Italy, 2016 It is worth highlighting that all the collected results are robust. Indeed, even if we increase the available information within the models, the coefficients remain statistically significant and we cannot observe relevant differences in the estimated signs. Additionally, the coherence of our coefficients is maintained even if the adopted insolvency procedures change. The next section proposes some conclusions based on the results illustrated above. Conclusions According to the theory of incomplete contracts, the threat of hold-up by one of the contractors depends both on the incompleteness of contracts and on costs that contractors should bear to include all possible “states of the world” (i.e., transaction costs). Moreover, the institutional environment has to safeguard contractors against opportunistic behaviors by influencing the business strategies of managers and entrepreneurs. Starting from the current knowledge, we shed new light on the key role of institutional efficiency in firm dynamics. Based on the results collected, we cannot reject our hypothesis, i.e., that judicial inefficiency negatively affects the creditors’ decision to request the intervention of the courts, postponing the payment deadline and decreasing the opportunity cost of alternative (non-judicial) means of dispute resolution. Nevertheless, the enforcing power of these alternative approaches is lower, supporting the debtors’ strategic behavior of substituting unsecured debt financing 1302 G. Falavigna, R. Ippoliti. The impact of institutional performance on payment dynamics: evidence... with supplier financing. This evidence may have significant implications for the whole economy – and even more so for small businesses, which represent a sizeable portion of the Italian manufacturing industry. The impact of debtors’ opportunistic behaviors on the financial health of small enterprises could be dramatic, greatly reducing their solvability and, in the worst cases, driving them out of the market altogether. Policy implications concern the opportunity to reform the organization of the courts as well as insolvency procedures, increasing judicial efficiency and, consequently, preventing hold-ups by the parties to a contract. The proposed approach is coherent with evaluations of the Italian judicial system by international institutions, such as the International Monetary Fund and the Organization for Economic Co-operation and Development, which stress the need to enhance the efficiency and effectiveness of civil procedures to ensure the smooth processing of cases in court. Hence, Italian policy makers should pursue a full reform of insolvency legislation, advancing the reorganization process that started in 2005 and 20066. Moreover, this reform should be complemented by improvements in related laws to increase bank lending, enhancing the likelihood that claims by individual creditors against a debtor are met. At the same time, policy makers could work on the so-called informal enforcement mechanism (i.e., reputation). Indeed, when legal enforcement works poorly, firms tend invest more in connecting with others to enhance contract enforcement via the reputation mechanism; additionally, better informal enforcement improves legal enforcement because it reduces firms’ incentives to bribe. Obviously, this set of elements may represent a great chance for policy makers to support national competitiveness on the global market, promoting entrepreneurship and removing barriers to entry. Even more importantly, these reforms could be implemented without diverting financial resources from other public interventions. Despite the validity of the results presented above, our work has some limitations and there is room to improve the current analysis. Indeed, we adopt indexes to estimate average payment times and our research could be developed further when micro data on payments, as well as on alternative (non-judicial) means of dispute resolution, become available. Moreover, depending on data availability, there might be opportunities to further validate the proposed interpretation concerning the different degrees of reliance on debt financing, testing whether debtors rely more on debt to finance operating costs when judicial enforcement is weaker. Future studies may thus provide policy makers with additional support in this reform process, steering the judicial system and its services toward a new age of efficiency. Acknowledgements Authors acknowledge support for the publication costs by the Deutsche Forschungsgemeinschaft and the Open Access Publication Fund of Bielefeld University. 6 The 2005 reform (Legislative Decree no. 35 of 2005), inspired by Chapter 11 in US bankruptcy law, makes the renegotiation of credit contracts easier, while the 2006 reform (Law no. 5 of 2006) modifies liquidation procedures. Journal of Business Economics and Management, 2020, 21(5): 1285–1306 1303 Reference Agrell, P. J., Mattsson, P., & Månsson, J. (2020). 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