Access to Collateral and the Democratization of Credit: France's Reform of the Napoleonic Security Code

• Published date: 01 February 2020
• Author: MURILLO CAMPELLO,KEVIN ARETZ,MARIA‐TERESA MARCHICA
• Date: 01 February 2020
• DOI: http://doi.org/10.1111/jofi.12846

THE JOURNAL OF FINANCE •VOL. LXXV, NO. 1 •FEBRUARY 2020

Access to Collateral and the Democratization

of Credit: France’s Reform of the Napoleonic

Security Code

KEVIN ARETZ, MURILLO CAMPELLO, and MARIA-TERESA MARCHICA∗

ABSTRACT

France’s Ordonnance 2006-346 repudiated the notion of possessory ownership in the

Napoleonic Code, easing the pledge of physical assets in a country where credit

was highly concentrated. A differences-test strategy shows that firms operating

newly pledgeable assets significantly increased their borrowing following the reform.

Small, young, and financially constrained businesses benefitted the most, observ-

ing improved credit access and real-side outcomes. Start-ups emerged with higher

“at-inception” leverage, located farther from large cities, with more assets-in-place

than before. Their exit and bankruptcy rates declined. Spatial analyses show that

the reform reached firms in rural areas, reducing credit access inequality across

France’s countryside.

∗Kevin Aretz is at Alliance Manchester Business School. Murillo Campello is at Johnson Grad-

uate School of Management, Cornell University and the National Bureau of Economic Research

(NBER). Maria-Teresa Marchica is at Alliance Manchester Business School. We are indebted to

two anonymous referees, an anonymous associate editor, and the managing editor (Amit Seru) for

helpful and constructive suggestions. We are also thankful to Manuel Adelino, Nittai Bergmann,

Charles Calomiris, Gilles Chemla, Alberta Di Giuli, Mara Faccio, Laurent Fr´

esard, Edith Gin-

glinger, Gaurav Kankanhalli, Mauricio Larrain, Kai Li, Ulf Lilienfeld-Toal, Noel Maurer, Roni

Michaely, Matteo Millone, Abhiroop Mukherjee, Giovanna Nicodano, Steven Ongena, Maurizio

Pisati, Zacharias Sautner, Reinhard Schmidt, Antoinette Schoar, David Thesmar, Giuseppe Vit-

tucci, and Baolian Wangfor their constructive and helpful insights. Comments from participants at

the 2015 European Finance Association Meetings (Vienna), the 14th International Conference on

Credit Risk Valuation (Venice), the 7th European Banking Center Conference (Tilburg), the 2016

Edinburgh Corporate Finance Conference, the 2016 Financial Intermediation Research Society

(FIRS) Conference (Lisbon), the 2016 UBC Summer Finance Conference (Vancouver), the 2016

Western Finance Association Meetings (Park City), the 2018 Finance, Organizations, and Mar-

kets (FOM) Conference (Hanover), and the 2018 Mitsui Symposium on Comparative Corporate

Governance and Globalization (Ann Arbor); as well as seminar participants at American Uni-

versity, Birmingham University, Bristol University, Columbia University, ESCP Paris, the Free

University of Bozen, IDC Herzliya, Paris-Dauphine University, St. Andrews University, Strath-

clyde University,and WHU Koblenz are also acknowledged. We are grateful to Marie-Elodie Ancel

from Universit´

e Paris Est Cr´

eteil, Giuliano Castellano from University of Hong Kong, Rod Cork

from Allen & Overy (Paris), and Philip Wood from Allen & Overy (London) for insightful discus-

sions about French laws, and Annalisa Ferrando from the European Central Bank for sharing

the SAFE index. We have read The Journal of Finance’s disclosure policy and have no conflicts of

interest to disclose.

[Correction added on 21 November 2019 after first online publication: The first line of the legend

of Table III directly below the second equation has been updated.]

DOI: 10.1111/jofi.12846

C2019 the American Finance Association

45

46 The Journal of Finance R

To allow for a more equal access to credit, I wish to see a rapid easing of

the pledge regime. Do I need to remind you that currently a borrower, for

example, a company, has to hand over the property that it pledges? Do you

know a modern country that works that way?

—Pascal Cl´

ement, Minister of Justice, addressing the French

Parliament on June 22, 2005

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 “nontransferable” (see Omar (2007) and Ancel (2008)). These legal

fictions limit the types of security interests that can be written on productive

assets and ultimately favor large, established, well-connected incumbents over

small, young, innovative newcomers (see, e.g., Fleisig, Safavian, and de la Pe ˜

na

(2006)). 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 dis-

tributional effects), business formation, and real economic outcomes.

Ordonnance 2006-346 derogated the notion of possessory asset ownership in

France, in existence since 1804. In 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 as-

sets 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 security interests to be charged to more than one party, mak-

ing it feasible for loans to be syndicated under multiple creditors, 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 differ-

entiates 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 provide unique insights into the distributional and wealth effects

of easing access to collateral. Changing the legal framework governing asset

ownership and alienability meant that firms were discretely yet differentially

endowed with “new assets” that they could pledge in credit transactions. Nest-

ing 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

The Democratization of Credit 47

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 term versus long term), their size, age, and credit access status

(“financing constraints”), among several dimensions that help us trace how ac-

cess to collateral shapes credit taking and corporate outcomes. We also gauge

the broader economic consequences of this process, including spatial reach and

allocation efficiency. Among 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 com-

prehensive data from Bureau van Dijk. We find that the reform significantly in-

creased the debt-taking of French firms with no access to public markets along

both the intensive margin (leverage ratios) and the extensive margin (propen-

sity to take out any debt at all). Notably, the reform only affected long-term

debt-taking (secured by hard assets). Using firms’ fixed assets intensity to iden-

tify effect heterogeneity,we show that the increase in debt ratios and the decline

in the proportion of “zero-leverage” firms occurred primarily among “high-fixed

assets intensity” firms. In particular, while the long-term leverage ratio of

high-fixed assets firms rose by about 7 percentage points after the reform, the

long-term leverage ratio of low-fixed assets firms rose by a mere one point.

The 6 percentage point difference is remarkable compared to the pre-reform

average leverage ratio of only 1.4%. Confirming the logic of our test, short-term

debt (which is not secured by hard assets) did not change across high- or low-

fixed assets firms. All our tests have firms matched on several predetermined

dimensions and account for firm- as well as industry-year fixed effects.

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 previ-

ous work on credit expansion has warned researchers and policy-makers about

credit that is indiscriminately awarded to “marginal borrowers” in the econ-

omy.1We examine three sets of real outcomes in our matched-DID tests: firm

spending, performance, and risk. Regarding the first set, we find that high-fixed

assets firms spent significantly more in capital investment and labor employ-

ment after the collateral reform. Regarding the second, we find that those same

firms observed higher sales and profitability rates in the years following the re-

form. Finally, we document that high-fixed assets firms observed a significant

decline in profit volatility and, ultimately, a comparatively lower probability

of filing for bankruptcy after the reform. Our analysis suggests that the 2006

collateral reform benefitted seemingly promising, creditworthy borrowers.

Our next step is to study whether the reform reached firms previously ra-

tioned in the credit market (“credit democratization”). We perform several sets

1Assunc¸˜

ao, Benmelech, and Silva (2014), for example, study a reform in Brazil that simplified

the sale of repossessed cars used as collateral for auto loans. That reform led to higher credit

availability and taking. However, it distinctively allowed for riskier borrowers to obtain loans for

more expensive cars, ultimately triggering higher default rates.