Access to Collateral and the Democratization of Credit

France's Reform of the Napoleonic Security Code

Several countries use security laws derived from the Napoleonic Code, a regime predicated on the notion of “possessory ownership.” Under the highly-formalized, centuries-old Code, physical assets are deemed to be “unique,” “whole,” and “non-transferrable”. These legal frictions ultimately limit the types of security interests that can be written on productive assets and favor large, established, well-connected incumbents over small, young, innovative newcomers. Institutional arrangements of this kind have detrimental consequences for financial markets and economic development, but the critical mechanisms that underlie these connections - and their reach - are not fully understood. This paper shows how a recent reform in France informs knowledge about links between the legal contracting framework, access to credit (level and distributional effects), business formation, and real economic outcomes.

Ordonnance 2006-346 derogated the notion of possessory asset ownership in France, in existence since 1804. By doing so, the 2006 reform allowed French firms to control and operate (in-house) 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 (such as machinery and equipment). In addition to expanding the set of assets that could be collateralized, the new regime 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. In further allowing for rechargeable interests, the reform also critically enhanced the pledgeability of hard immovable assets (land and buildings). The new law had no bearing on firms' ability to offer liquid assets as collateral. Notably, Ordonnance 2006-346 did not introduce changes related to the balance of power between contracting parties, asset seizure procedures, or judicial intervention. This starkly differentiates it from most other credit reforms, which have promoted the notion of “strengthening creditors' rights” as a way to ease credit access.

The wrinkles in the process through which France reformed its security code system allow for unique insights into the distributional and wealth effects of easing access to collateral. Nesting pairwise-matching in difference-in-differences (DID) estimations, we build on the prior that firms whose operations relied most intensely on hard assets could be favored by a reform that distinctly enhanced their ability to pledge that class of assets in credit agreements. In this setting, we contrast and compare firms according to the types of assets more intensely used in their production processes (hard versus liquid), according to the nature of the contracts they sign (short- versus long-term), their size, age, and credit access status (“financing constraints”), among several dimensions that help us trace how access to collateral shapes credit taking and corporate outcomes. We also gauge larger economic consequences of this process, including spatial reach and allocation efficiency. Amongst the most innovative margins we consider is the impact of the collateral reform on start-ups, assessing effects that speak to the issues of business formation, growth, and survival.

We first study the effect of Ordonnance 2006-346 on firm credit using comprehensive data from Bureau van Dijk. We find that the reform significantly increased the debt-taking of French firms with no access to public markets along both the intensive margin (leverage ratios) and the extensive margin (propensity to take out any debt at all). Notably, the reform only affected long-term debt-taking (secured by hard assets). We show that, while the long-term leverage ratio of high-fixed assets firms rose about 7 percentage points after the reform, the long-term leverage ratio of low-fixed assets firms rose by a mere 1 point. The 6%-point difference is remarkable when compared to the pre-reform average leverage ratio of only 1.4%.
After establishing that firms operating assets contemplated by the 2006 collateral-menu reform are able to issue more secured debt, we look into a number of real-side outcomes. This is an important examination since previous work on credit expansion has warned researchers and policy-makers about credit that is indiscriminately awarded to “marginal borrowers” in the economy. We examine three sets of real outcomes in our matched-difference-in-differences tests: firm spending, performance, and risk. We document that high-fixed assets firms spent significantly more in capital investment and labor employment after the collateral reform; they observed higher sales and profitability rates; and they witnessed a significant decline in profit volatility and, ultimately, a comparatively lower probability of filing for bankruptcy after the reform.

Our next step is to study whether the reform reached firms previously rationed in the credit market (“credit democratization”). We perform several sets of analyses on this front. We first break out our main tests across characteristics that commonly speak to firms' ability to access credit. In particular, we look at whether the collateral reform had significantly differential effects on firms that are small, young, or are classified as financially constrained according to a French-specific index of financial constraints based on the European Central Bank (ECB)/European Commission (EC) Survey on Access to Finance of Enterprises (SAFE). A matching-triple-differences test approach shows that these likely credit-rationed firms gained the most access to credit following the repudiation of possessory ownership. Under the same testing framework, we look at the real outcomes we considered for our aggregate sample (spending, performance, and risk). Our tests show that investment, hiring, sales, and profitability were particularly positively affected by the reform among high-fixed assets firms that were small, young, and financially constrained. At the same time, those subsets of firms were differentially more likely to observe reductions in profit volatility and failure rates.

Our base results suggest that Ordonnance 2006-346 helped democratize credit access toward existing firms that likely starved for the funding of viable projects. Yet, the proceeding analysis left out a margin that is often ignored in the examination of credit reforms: the establishment of new firms. Using additional data from Bureau van Dijk and from the French Census (INSEE), we first show that “at-inception” leverage ratios of start-up businesses operating more fixed assets increased significantly more following the collateral reform than the leverage ratios of industry-year-location-matched start-ups operating less fixed assets. Next, we dig deeper into post-reform outcomes for start-ups, assessing the reform's impact on metrics that gauge business formation, growth, and survival. Among other results, we show that, after the collateral reform, start-ups operating more fixed assets were geographically born farther away from France's large cities; where access to finance is scarce, and when available, complicated by frictions commonly associated with physical distance between borrowers and financial providers. We also show that the initial size of start-ups operating more fixed assets considerably increased with the reform. Our estimations also show that high-fixed assets start-ups grew faster after the collateral reform; this while the growth rate of matched low-fixed assets start-ups declined. Finally, we look at general exit and bankruptcy rates for start-ups in France around the reform as a function of those firms' fixed-asset usage. General exit and bankruptcy rates of high-fixed assets start-ups became markedly lower than those of low-fixed assets start-ups after Ordonnance 2006-346.

We also look at the issue of credit democratization via a geography-based analysis of the reform's effects. Several studies emphasize the importance of firm location in accessing credit:
a higher density of financial institutions, in particular in and around urban centers, lowers the informational cost of credit acquisition. As such, firms located in rural areas face a significant disadvantage in accessing credit. Using spatial-point analyses, we show that firms located away from metropolitan areas gained the most credit access from the collateral reform. We also compute a Gini index of corporate credit to gauge whether the reform reduced inequality in credit access within and across different jurisdictions in France. Before the reform, 90 out of 96 French departments had a Gini index exceeding 0.90, implying that the credit market in virtually every department was dominated by a handful of large firms.  After the reform, only 19 departments registered an index above 0.90. Remarkably, the largest drops occurred in rural departments, far from the main French urban areas and financial centers. The geography-based analysis we present adds to the understanding of how economic policy percolates throughout a country, providing perspective to decision-makers concerning their policy goals.

We end our study tracing the economic effects of the reform at the macro level. We find that the derogation of the anachronic Napoleonic security code led to far reaching changes in the make up of investment and growth in the French economy. It prompted an increase in the elasticity between investment and value added, in particular in those industries mostly affected by the reform. It also allowed for more borrowing by firms operating in industries heavily reliant on external financing. All combined, our results point to a significant improvement in capital allocation efficiency in the economy. This is an important effect from a policy-making perspective since reforms of this nature may require fewer resources to implement and maintain than reforms that focus, for example, on law enforcement and judicial intervention.