Finance and Labour Reallocation: The

consequences of a liquidation reform

Rafael Carlquist R. de Araujo

Advisor: Felipe Iachan

Rio de Janeiro - 2018

EPGE-FGV
Contents

1 Abstract 4

2 Introduction and Literature Review 5

2.1 The Intersection of Labour and Credit Markets . . . . . . . . . . . . . . . . . . . . . . . 6

2.2 The Brazilian New Bankruptcy Law . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7

3 Conceptual Framework 10

4 Empirical Application 14

5 Data 17

6 Estimation Strategy 20

7 Conclusion 25

8 Appendix 30

8.1 A possible extension . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

8.2 Additional tables . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30

1
List of Tables

1 First sector classification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

2 Second sector classification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

3 First stage regression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

4 Second stage regression . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

5 Estimation with the first tangibility classification . . . . . . . . . . . . . . . . . . . . . . 24

6 Estimation with the second tangibility classification . . . . . . . . . . . . . . . . . . . . 25

7 Second stage regression with the second classification for tangibility . . . . . . . . . . . 31

8 Second stage by year with first tangibility classification . . . . . . . . . . . . . . . . . . . 31

9 Second stage by year with second tangibility classification . . . . . . . . . . . . . . . . . 32

10 Estimation with tangibility and year dummies . . . . . . . . . . . . . . . . . . . . . . . . 33

11 Estimation with second tangibility measure and year dummies . . . . . . . . . . . . . . 34

12 Minimum requirements - potential extra-jurisdiction threshold . . . . . . . . . . . . . . . 35

2
List of Figures

1 Private-Credit to GDP ratio before and after the reform . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 08

2 Sectoral and total production correlation by region . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

3 Distribution of tangibility measure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

4 Inefficiency and potential extra-jurisdiction correlation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

3
1 Abstract

In 2005, the Brazilian bankruptcy law was changed to improve secured creditor’s protection. I explore

the bankruptcy reform together with heterogeneity of the judicial efficiency, at the municipal level,

and heterogeneity of the firm’s asset tangibility, at the sectoral level, to study possible effects on

labour reallocation. By applying an instrumental variable approach, I find that firms operating on

municipalities with a more efficient judicial system observed a higher increase in their labour force after

the reform, and that this effect was stronger on firms operating in sectors which use more tangible

assets.

keywords: bankruptcy; bankruptcy reform; labour market; court congestion; labour reallocation; struc-

tural change.

4
2 Introduction and Literature Review

The purpose of this research is to analyze empirical evidence that the financial market can affect labour

market in a structural way. The Brazilian bankruptcy reform of 2005, which will be more explored in

the coming sections, changed the institutional environment for lenders and corporate borrowers. By

exploring a panel data set, which documents all formally employed workers, and data on the efficiency

of judicial court at the municipal level, I am able to explore the heterogeneity of the credit market

institutions across time (before and after the reform) and across municipalities (municipalities with

different levels of judicial efficiency). A third layer of heterogeneity is added to the problem by exploring

sectoral differences on the type of assets employed in each industry.

I apply an instrumental variable approach to study the effect of the reform and judicial efficiency

on labour reallocation and wages. In Brazil, there are minimum requirements for a municipality to

become eligible to posses a judicial court. When the requirements are not met, the cases are judged

by a neighbouring municipality with a seat in a judicial district. For those municipalities with a seat,

a higher number of neighbours that do not meet the requirements generates a higher court congestion,

that is, more cases to be judged. Thus, this measure of non-eligible neighbours is taken as an instrument

for court efficiency.

I find that after the bankruptcy reform, the labour force increases in municipalities with a more efficient

court and that this effect is stronger on sectors that can be classified as sectors which employ more

tangible assets. Considering the effects of the reform on wages, I find no statistically significant results

of judicial efficiency on wages.

This research is related to the literature on financial frictions and firm decision, although, as presented

in the next section, the bulk of the literature has been more concerned with firm investment than labour

demand when it comes to study financial frictions. The research is also related with the structural

change literature, since the main effect explored is the reallocation of labour between sectors. The

next two subsections discuss more the related literature. The next section presents a simple conceptual

framework, illustrating the mechanisms which I want to study. I then present an empirical specification

followed by a description of the data sets and the identification strategy. The final sections present

the results and conclusion.

5
2.1 The Intersection of Labour and Credit Markets

The literature linking financial markets and corporate investment has presented several possible mech-

anisms to take into account heterogeneity in firms’ investment decisions. Credit market frictions can

arise in an environment with asymmetric information such as adverse selection as in Majluf and Myers

(1984) and moral hazard as in Holmstrom and Tirole (1997), generating different costs of inside and

outside liquidity and differences in capital cost for firms, effects which would not arise in a canonical

perfect information model.

Mechanisms underlying the link between financial markets and employment, however, have not devel-

oped into a consensus. For example, Petrosky-Nadeau (2014), Garin (2015) and Boeri et al. (2015)

start from the idea that hiring costs of a labour market with search frictions must be financed in an

also frictional credit market with asymmetric information, thus generating a link between financial

markets shocks and the labour market.

Other articles as Wasmer and Weil (2004) and a dynamic extension of the same model by Petrosky-

Nadeau and Wasmer (2013) develop an economy where hiring costs must be financed by a credit

market which presents a search and matching problem between firms and banks.

In the empirical literature, Sharpe (1994) shows the existence of a higher employment elasticity for

firms that are smaller, highly leveraged and face more procyclical demand. The underlying idea is

the presence of adjustment costs of the labour force, implying that firms try to dampen fluctuations

of labour input, generating a “labour-hoarding”. With imperfect capital markets, this dampening is

constrained to a non-optimal path. Most of the following articles apply this same idea to justify

movements in employment.

Exploring a maturing debt approach (as was done to analyze investment decision in Almeida et al.

(2011)) Benmelech et al. (2015) study the impact of financial restrictions on firms during the Great

Recession. Firms with more maturing debts during the crisis had the biggest fall in the number of

employees, even controlling for leverage and size. A similar approach is presented in Benmelech et al.

(2017) for the Great Depression, where the interaction between maturing debt and local banks failures

affects the layoff of workers. Studying this bank-firm relationship, Chodorow-Reich (2014) shows that

firms which had loan relationships with more fragile institutions during the Great Recession reduced

employment more than firms which had relationships with healthier institutions, that is, a cost to

switch lenders would explain the difficulty in getting new loans to maintain the labour force.

6
Those previous papers are interested in how employment can vary within firms along the business

cycles in the presence of shocks in the credit market. Nonetheless, an even smaller literature asks if

financial frictions can affect employment in a structural way. For example, a model describing how

finance can affect structural unemployment is given by Acemoglu (2001). The author studies how

differences between the credit markets in Europe and USA can generate persistent unemployment,

beyond the most common explanation of Europe’s rigidity in labour law. In his model, technological
1
changes arrives faster in the market in economies with less credit frictions, boosting job creation.

I intend to focus my research not on short term effects of financial frictions on labour, but on the

more structural aspects of it. The reason I do not follow the bulk of the literature is that I want

to explore the episode of the Brazilian bankruptcy reform, which can be seen as a structural change

in Brazil’s credit market rather than a transitory credit shock. To understand the connection of the

bankruptcy reform and the credit markets, the next subsection presents a brief overview of the law

reform. Following that, the next section present a simple framework to access the ideas underlying the

effects of credits market changes on the labour market.

2.2 The Brazilian New Bankruptcy Law

Following the exposition in Araujo et al. (2012), the previous legislation regulating the Brazilian

bankruptcy procedure ranked the obligations of insolvent firms as: (1) labour claims then (2) tax claims,

(3) secured creditors’ claims and finally (4) unsecured creditors’ claims, resulting in an environment

very punitive to creditors. Besides this succession problem, the whole process was slow and costly,

damaging the firm’s value along the way. Theoretically, the firm’s value in case of default would be

very low and the credit market would ask for a higher return for any loan and/or for higher value of

collateral.

The new legislation from 2005 introduced important changes as: (1) faster bankruptcy process; (2)

ranked the obligations as labour then secured creditors’ claims, tax claims and unsecured creditors’
1 As the models above were thought to explain employment in developed countries, no mechanisms considered other

institutions of the labour market such as, for example, informality. For developing countries, however, the sizable
informal sector could change the way finance affects labour. Although, the informal sector is usually seen as a result of
labour market rigidity and taxes structure, as in Meghir et al. (2015), there has been research about a “credit channel”
affecting the size of the underground economy. Antunes and Cavalcanti (2007), D’Erasmo and Boedo (2012) and Quintin
(2008) study a calibrated dynamic model where entrepreneurs operating in the informal sector cannot enforce financial
contracts, in a way that their decision on capital input is greatly restricted to its own wealth. Applying these models
to Brazil’s data, D’Erasmo (2016) found a positive impact of the Brazilian bankruptcy reform on the size of the formal
sector. Finally, Straub (2005) considers a model with formal and informal credit markets. Those models share the idea
of competitive labour markets and the underlying mechanism that after paying for the cost of being formal, firms benefit
from better access to credit markets through the legal system.

7
claims; (3) introduced a cap of 150 minimum wages for each worker, once this cap was reached se-

cured creditors start to posses the priority of obligations; (4) practically introduced the reorganization

process, which was possible in the old legislation but was used only as a way to postpone bankruptcy.

Theoretically, the return for loans, under the new legislation and the requirement for collateral, should

be lower, implying a higher level of debt at the firm’s level. Araujo et al. (2012), applying a diff-in-diff

approach show that it indeed happened. The authors found a significant increase in firms’ long-term

debt - which is more correlated with secured creditors. The improvement in the credit market envi-

ronment was strong, as illustrated in figure 1.

Source: adapted from Araujo et al. (2012)

For reasons which will be clearer soon, it is interesting to note that the authors did not find hetero-

geneity of results for firms with different levels of asset tangibility, as measured by the ratio between

PP& E (property,plant and equipment) and total assets.

The law is important but so is enforcement. That is the message from Ponticelli and Alencar (2016).

In Brazil, a bankruptcy process is ruled at the municipal level. Applying an instrumental variable

approach, the authors show that, after the reform, firms operating in municipalities with less congested

courts - seem as more efficient courts - experienced: (1) higher increase in the use of secured loans; (2)

higher increase in investment; (3) higher increase in the value of output.

8
Contrary to the results presented by Araujo et al. (2012), the authors found that the effects were

stronger for firms with more tangible assets. The reason to expect this result is the following: firms

which hold more tangible assets are more likely to access credit through secured loans; as secured

creditors were the most benefited by the new law, those firms is more likely to be the most benefited.

Thus, the bankruptcy reform has generated three important variations: (1) across time: the legislation

before and after the reform; (2) across municipalities - municipalities with different levels of justice

efficiency experienced differently the effects of the reform; (3) across firms - firms operating in sectors

which operate with higher levels of asset tangibility, were more benefited than firms operating in other

sectors. I want to study how those three components can explain movements in the labour market, as

described in the next section.

9
3 Conceptual Framework

In this section I build the simplest possible model to explain the mechanism which I want to test. The

generalization is left only to the reduced form approach described in the next section.

Suppose an economy with two firms (i = 1, 2), operating at different sectors s = s1 , s2 and locations

j = j1 , j2 . For simplicity, I assume each firm operates a Cobb-Douglas production function with

decreasing returns to scale on labour (l) and capital (k).

fi = (k αi l1−αi )ρ (1)

Where αi > 0 and 0 < ρ < 1

The labour market is competitive with an exogenous and constant supply L. Denote the wage by w.

The capital market is imperfect. The price (r) of capital is exogenous, firms can borrow as much

capital as they want, up to a limit, denoted by λj,s . Later I will assume a functional form for this

limit. Notice that I index the limit by the sector and location of the firm. I interpret this limit as a

reduced form approach to incentive constraints - from the firm’s owners, or the manager, for example

- that must be satisfied.

Denote by li∗ and ki∗ the optimal unconstrained levels of capital and labour, which solve problem 2

max fi (ki , li ) − wli − rki (2)

ki ,li

Under the imperfect capital market condition, each firm solves problem 3

max fi (ki , li ) − wli − rki

ki ,li
(3)
subject to ki ≤ λji ,si

It is critical to the results I want to study to assume that firms are capital constrained, that is

λsi ,ji < ki∗ . With this hypothesis, the optimal capital demand in problem 3 is given by ki∗∗ = λj,s and

the labour demand is given by expression 4

10
   ρ(1−α1
w i )−1
li∗∗ = λ−αi ρ (4)
ρ(1 − αi ) j,s

Therefore, the labour market equilibrium condition can be written as equation 5

# ρ(1−α1 # ρ(1−α1
wλ−α 1ρ
wλ−α 2ρ
" "
1 )−1 2 )−1
j1 ,s1 j2 ,s2
+ =L (5)
ρ(1 − α1 ) ρ(1 − α2 )

Finally, I specify λs,j as λs,j = eδλj λs .

The parameter λs is sector specific. It can be seen as related with the scrap value of a firm if it decides

to go bankrupt. A firm which operates in a sector where its assets are easily resold or more tangible

will present a greater λs .

λj is a location effect, more specifically, at the municipal level. I interpret this parameter as the

efficiency of the judicial system in the municipality in which the firm operates. A less efficient justice

(a smaller λj ) makes the bankruptcy process more costly and time consuming, deteriorating the firm’s

scrap value.

The last parameter δ is the same across all firms and all municipalities. It can be seen as capturing

the effect of the bankruptcy legislation, common to all firms at the national level.

Those three parameters deliver three potential heterogeneity: (1) λj , spatial heterogeneity across

municipalities; (2) λs differences across sectors; (3) δ different legislation across time.

My interest is to study the effect of a change in the legislation (δ) on the allocation of labour. Consider

a change in δ, small enough that firms continue being capital constrained. Differentiating expression

5 with respect to δ, I obtain that the effect of a better bankruptcy legislation on wage is positive, the

result is stated in lemma 0.

Lemma 0: The effect of an increase in δ is a increase in w, that is

∂w
>0 (6)
∂δ

Demonstration: By inspection of expression 5, an increase of δ generates a decrease of the numerator

of each labour demand. The only variable that can possibly adjust is the wage variable w, which must

increase for the equality to hold. 

11
An increase in w will change the allocation of labour. The labour market equilibrium guarantees that

it cannot be that both firms will increase or decrease the labour force. It must be so that one will

increase its labour force, while the other one will decrease the quantity o labour.

Differentiating expression 4 with respect to δ I obtain the first comparative statistics, described in

lemma 1.

Lemma 1: If both firms have the same values for αi , λj , the general equilibrium effect of an increase

in δ is an increase in the labour force of the firm with more tangible assets (higher λs ) and a decrease

in the labour force for the firm with less tangible assets.

Demonstration: Assume, without loss of generality, that λs=1 > λs=2 . Differentiating expression 4

with respect to δ results in expression 7

∂li∗∗
 
∂w
=c − αi ρλj λs (7)
∂δ ∂δ

where

  ρ(1−α1 )−1
1 w −αi ρ i
c= λj,s <0
ρ(1 − αi ) − 1 ρ(1 − αi )

As the derivative on wages, given by expression (6), is the same for both firms and the values for αi , λj

are also the same for both firms, then:

   
∂w ∂w
− αi ρλj=1 λs=1 < − αi ρλj=2 λs=2 (8)
∂δ ∂δ

That is the expression in brackets of 7 is different for each firm. It cannot be the case that both firms

increase or decrease the labour force, since the labour supply is exogenous, neither can be the case

that the labour force will remain unchanged, since it would contradict expression 8. Thus, the labour

force increases in one firm - the firm with more tangible assets - and decreases in the other one. 

Lemma 1 shows that controlling for αi , λj the general equilibrium effect of an increase in δ is an

increase in the labour force of the firm with more tangible assets and a decrease in the labour force

for the firm with less tangible assets, which I will call a labour reallocation.

The comparative statistics with respect to the efficiency of justice follows the same steps and is pre-

sented in Lemma 2, for later reference.

12
Lemma 2: If both firms have the same values for αi , λs , the general equilibrium effect of an increase

in δ is an increase in the labour force of the firm which operates in a municipality with a more

efficient justice system (higher λj ) and a decrease in the labour force for the firm which operates in a

municipality with a less efficient justice.

Lemma 2 shows that controlling for αi , λs the general equilibrium effect of an increase in δ is an

increase in the labour force of the firm which operates in a more judicially efficient municipality and

a decrease in the labour force of the firm which operates in a less judicially efficient municipality.

Finally, the comparative statistics of wage with respect to the efficiency of justice is stated in lemma

3.

Lemma 3: The increase in wages w, due to an increase in δ, as stated in lemma 0, is stronger for

higher values of judicial efficiency, that is, higher λj .

Demonstration: By inspection of expression 5, an increase in δ generates a decrease of the numerator

of each labour demand, and this decrease is higher for higher values of λs . Thus, as wage is the only

variable of adjustment, the increase in w is higher for higher values of λs . 

Lemma 3 shows that, after the reform, municipalities with a more efficient judicial system observed a

higher increase on wages.

An empirical approach to test these mechanisms is described in the next section.

13
4 Empirical Application

An empirical version of the mechanism described in Lemma 2 of the previous section, could be stated

as in equation 9

ls,j,t = αt + αs + β1 (inef fj ) + β2 (ref )t .(inef fj ) + s,j,t (9)

where: (ref )t is a dummy variable, equals to zero on the pre-reform period and equals to one after;

(inef f )j is the inefficiency of the judicial system on location j; αt is a time fixed effect and αs is a

sector fixed effect.

To get rid of the fixed effect and potential auto-correlation of the error term, I propose to estimate

equation 9 in first difference as in equation 10

∆ls,j = α + β1 (ref )t .(inef fj ) + s,j + s,j (10)

Where α is a constant. Testing the mechanism of the previous section is to test whether β1 < 0, that

is, firms operating in municipalities with a more efficient judicial system observed an increase in their

labour force.

An empirical version of the mechanism described in Lemma 1 of the previous section, could be stated

as in equation 11

ls,j,t = αt + αs + β1 (Highs )(inef fj )+

β2 (Lows )(inef fj ) + β3 (Highs )(ref )t .(inef fj )+ (11)

β4 (Lows )(ref )t .(inef fj ) + s,j,t

where: (Highs ) is a dummy variable, equals to one if sector s belongs to a group of sectors which

employs more tangible assets; (Lows ) is a dummy variable, equals to one if sector s belongs to a

group of sectors which employs less tangible assets; (ref )t is a dummy variable, equals to zero on

the pre-reform period and equals to one after; (inef f )j is the inefficiency of the judicial system on

location j; αt is a time fixed effect and αs is a sector fixed effect. The construction of the groups of

high tangibility and low tangibility will be discussed in the next section.

14
Again, to get rid of the fixed effect and potential auto correlation of the error term, I propose to

estimate equation 11 in first difference as in equation 12

∆ls,j = α + β1 (Highs )(ref )t .(inef fj ) + β2 (Lows )(ref )t .(inef fj ) + s,j (12)

Testing the mechanism of the previous section is to test whether β1 < 0 for sectors with more tangible

assets and β2 > 0 for sectors with less tangible assets.

The data studied, which will be explained on the next section, presents multiple periods. I then define

∆ls,j to be the difference between the averages of labour force before and after the reform, summed

by sector (s) within each municipality (j). Note that the variable (inef f )j can be interpreted as a

continuous treatment variable, where the treatment is the bankruptcy reform. Municipalities with an

efficient judicial system will experience the full impact of the reform, while a municipality with a very

inefficient system will observe no impact.

Testing the result of lemma 3 can be done by equation 13, where I want to test whether β1 < 0.

∆ws,j = α + β1 (ref )t .(inef fj ) + s,j (13)

In the conceptual model presented in the previous section the labour market is frictionless, which

generates the homogeneity of wages across sectors. Nonetheless, it is reasonable to suppose high

transition costs for workers to change from one firm to another. These costs can be seen as search

costs or due to job-specific human capital accumulation.

Thus, the effect on wages could be heterogeneous among sectors. From one side, it could be that

firms more benefited by the new law would offer higher wages to attract more workers, while less

benefited firms would offer lower wages to retain less workers. From another side, the effects could

be the opposite if it were the case that workers transitioning - from the less benefited sector to the

other sector - lose job-specific human capital, thus lowering their productivity and wage. Meanwhile,

in the less benefited sector, wages go up, because now in the data I observe a selection of workers who

firms decided to keep because of their higher productivity in the sector. Which side makes sense is an

empirical question.

The heterogeneity of wages is not presented in the conceptual model, thus I wish to test if the assump-

tion of homogeneous effect on wages is a reasonable one.

15
Equation 14 is the empirical version of that mechanism, which has the same specifications as in 10,

except that now I want to test if municipalities with a more efficient judicial system observed a higher

increase on wages and if that effect is homogeneous across sectors, even if some sectors were more

benefited from the law reform other sectors. That is, I want to test whether β1 = β2 .

∆ws,j = α + β1 (Highs )(ref )t .(inef fj ) + β2 (Lows )(ref )t .(inef fj ) + s,j,t + s,j (14)

16
5 Data

For the judicial system variables, the CNJ (National Council of Justice - Conselho Nacional de Justiça)

through its program "Justiça em Números" provides data on the number of judges, pending cases,

sentences and new cases for every justice court in the country. Unfortunately, the data set ranges from

2015 to 2017, that is, after the reform. Ponticelli and Alencar (2016) used a data set from "Justiça

Aberta", also a program of CNJ, where the data ranges from 2009-2017 (also after the reform), although

the authors used data only for the year of 2009. I will be using the data from "Justiça em Números"

and interpreting the average data of 2015-2016-2017 as a proxy to the variables I am interested in for

the period of 2005-2017.

h i
#pendingcases
With this data set, the variable (inef f )j can be defined as (inef f )j = log #judges , that is,

the log of the ratio between the number of pending cases and the number of judges on location j.

I cannot distinguish on the data which cases corresponds to bankruptcy cases. Thus, the ’pending

cases’ and ’number of judges’ variables are taken to be the those corresponding to the civil courts of

the municipality. There are municipalities which do not have a separate court for civil cases, those are

usually small municipalities with an unique court. For those, the variables are taken to be the ones

corresponding to this general court. Finally, some municipalities have courts specialized in bankruptcy

process, for this case the variables assigned where those from this specific court. All the results consider

only municipalities which are a seat of a judicial district. Municipalities which do not posses a court

of their own is dropped out of the sample.

Data from employer-employee variables comes from RAIS (Relação Anual de Informações Sociais),

which documents all formally employed workers. For each job observation there is information on

the municipality location, worker’s ID (CPF - cadastro de pessoa física), firm’s ID (CNPJ - cadastro

nacional de pessoa jurídica), date of admission, month of separation, wage, sector information based

on the CNAE classification , working hours among other variables. I build two different data sets

using two different aggregations of the CNAE classification: (1) in the first one the data is grouped in

sectors by the less complex measure, where each sector is classified by a letter as described in table

1. In this classification there is more variety of sectors, although each sector corresponds to a larger

number of firms when compared to the other aggregation; (2) in the second data set, I select only firms

in industrial sectors, and apply a more refined classification, as stated in table 2. The data ranges

from 2002 to 2009.

17
 Table 1: First sector classification

Code
Farming A
Mining B
Manufacturing C
Electricity,gas, water D/E
and waste services
Construction F
Trade G
Transportation and H
warehousing
Information J
Finance and Insurance K
Real state L
Management and N/S
other services
Education services, health P/Q
care and social assistance
Accommodation and food I
services
Source: IBGE

Finally, I use statistics from IBGE (The Brazilian Institute of Geography and Statistics) about popu-

lation at municipal level (from the population census) and sectoral production.

To map the relation between the CNAE sector classification and a measure of asset tangibility I follow

two approaches.

The first follows Almeida and Campello (2007) and Sharpe (1994). In this methodology I group

sectors in two discrete measures - high tangibility and low tangibility. The group is determined by

the correlations between sectoral production and total production, that is, sectoral GDP and total

GDP. The idea underlying this classification is that for a firm operating in sectors which are more

cycle-sensitive, a negative shock on the economy is more likely to affect all best alternatives uses of

the firm’s assets, decreasing its tangibility/saleability.

The classification will depend on the macro geographical region, because as illustrated in figure 2,

those correlations vary substantially among different regions. For each macro region, the sector which

falls below the mean is classified as high tangibility, otherwise is classified as low tangibility.

The second approach follows Braun (2003). The measure of tangibility is calculated by the PB&E

ratio, that is, the ratio between the value of property,building and equipment of a firm over its total

18
 Table 2: Second sector classification

Industry Tangibility Capital intensity

Beverages 0.2794 0.0620
Fabricated metal product 0.2812 0.0531
Food product 0.3777 0.0616
Footwear, except rubber or plastic 0.1167 0.0181
Furniture, except metal 0.2630 0.0390
Glass and product 0.3313 0.0899
Industrial chemicals 0.4116 0.1237
Iron and steel 0.4581 0.1017
Leather product 0.0906 0.0324
Machinery, electric 0.2133 0.0765
Machinery, except electrical 0.1825 0.0582
Misc. petroleum and coal products 0.3038 0.0741
Non-ferrous metal 0.3832 0.1012
Other chemicals 0.1973 0.0597
Other manufactured products 0.1882 0.0393
Other non-metallic mineral products 0.4200 0.0684
Paper and products 0.5579 0.1315
Petroleum refineries 0.6708 0.1955
Plastic products 0.3448 0.0883
Pottery, china earthenware 0.0745 0.0546
Printing and publishing 0.3007 0.0515
Professional and scientific equipment 0.1511 0.0525
Rubber products 0.3790 0.0656
Textiles 0.3730 0.0726
Tobacco 0.2208 0.0181
Transport equipment 0.2548 0.0714
Wearing apparel, except footwear 0.1317 0.0189
Wood products except furniture 0.3796 0.0653
Source: Adapted from Braun (2003)

assets value. This measured was computed in Braun (2003), for U.S firms contained in the Compustat

data base for the period 1986-1995. The average value of this measure for the firms is presented by

sector in table 2. This second approach is a different view of the concept of asset tangibility; instead of

interpreting tangibility as saleability, this approach interpret tangibility as an intrinsic characteristic

of the asset hardness. The distribution of this measure of tangibility is described in figure 3. Again,

I classify a sector as being high tangibility if its measure lies above the mean, and low tangibility

otherwise.

19
Source: (Own elaboration). The correlations were calculated using data from IBGE on regional real GDP from 1985 to
2009.

6 Estimation Strategy

Explaining the instrumental variable approach is the goal of this subsection.

The main variable of interest is (inef f )j which can be interpreted as a continuous treatment variable,

where the treatment is the bankruptcy reform. As pointed in Ponticelli and Alencar (2016), the

problems with estimating equations 10,14 without an instrumental variable are two:

• An omitted variable problem: as I only have data for court congestion after the reform, then

it could be that municipalities with better institutions anticipated the effects of the reform,

which made them invest more in the judicial system to take advantage of the new law. In those

municipalities I could observe higher levels of investment in capital, private debt and labour

demand because of those better institutions and not only because of the new law.

• A self selection problem: since the firms do not randomly choose their local of operation, it could

be that the sorting of firms among different municipalities already imposed correlations between

the variables of interest and court congestion.

To avoid those problems I follow the identification strategy from Ponticelli and Alencar (2016). In

20
 Source: (Own elaboration). The data is from Braun (2003)

Brazil, small municipalities are not eligible to become a seat of a judicial district, in a way that the

judicial disputes at these locations are solved in a neighbouring municipality, seat of a judicial district.

The instrument for the efficiency of justice in location j is the number of neighbouring municipalities

which are not eligible to be a judicial seat; the conditions on which it occurs are defined in table A1 2 .

After controlling for variables determining the municipality size - which are all observed - this measure

should be exogenous.

Thus, the first stage regression is given by expression 15

(inef f )j = α0 + α1 (neighbour)j + ρX̄j + ηj (15)

Where X̄j is a vector of controls, mainly the number of neighbours, as a way to control for geographical

effects such as coastal location. Finally, the observations are weighted by the average number of firms

of each municipality and sector on the years being considered.

2 For Amazonas and Distrito Federal all municipalities are seats of judicial districts, thus I dropped them out of the
sample

21
Results

The first stage regression, which gives the predicted value of the judicial inefficiency as a function of

the number of potential extra-jurisdiction (number of neighbours) is illustrated in figure 4, where both

variables are weighted by the average number of firms in the municipality from 2006 to 2009.

Source: (Own elaboration)

The results of the regression is given in table 3; the variables are weighted by the average number of

firms. The measure of potential extra-jurisdiction is positively correlated with the measure of judicial

inefficiency; the effect is statistically significant even after controlling for the number of geographical

neighbours. The sign was as expected, more potential neighbouring municipalities without a court of

its own will generate more cases to be judged in the municipality which is a seat of the judicial district.

It is interesting to note that the sign of the ’Geographical Neighbours’ coefficient is positive, contrary

to the sign found by Ponticelli and Alencar (2016).

For the second stage of the regression I chose two features as the dependent variable: (1) the number of

workers 3 to study the transition of labour force between sectors; (2) average wage by hour to study the

effects on wages. Firms are aggregated by the CNAE classification, within their municipalities. Wages

were deflated by the consumer price index IPCA, from IBGE. The basis year is 2002. All regressions

were weighted by the average number of firms in each pair ’CNAE,municipality’, where the average is
3 when computing the measure of workers I weight them by the number of months worked in the firm

22
 Table 3: First stage regression

Model 1 Model 2
Potential extra-jurisdiction 0.78∗∗∗ 0.33∗∗∗
[0.07] [0.12]
Geographical Neighbours 0.38∗∗∗
[0.08]
constant 0.05∗∗∗ 0.04∗∗∗
[0.003] [0.003]
R-squared 0.19 0.70
No. observations 2354 2354
F-statistic: 108.74 86.41
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01

taken across the years 2006-2009. All results considers the period 2002-2005 as the pre-reform period,

that is, the steady state from which the differences are taken.

The results for the second stage are presented in table 4, using the data set constructed with the first

approach of asset tangibility, which results in more firms and sectors being observed. In this table I do

not distinguish between high tangibility and low tangibility sectors. The signs are as expected. Firms

in municipalities with a more congested court experienced a decrease in their amount of labour. The

effect on wages is not statistically significant, although the sign was as expected.

Table 4: Second stage regression

∆ hourly wage ∆ labour force1

Inefficiency -0.1678 −78.3∗∗∗
[0.1446] [23.71]
log(avg neigh pop) −0.1107∗∗∗ -0.98
[0.0178] [3.10]
constant 3.5969∗∗∗ 467.6∗∗∗
[1.0211] [158.6]
No. observations 30261 30261
Fixed effect: State, Sector State, Sector
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01
1 in thousands

The next step is to include the tangibility classification. Applying the first approach (the saleability

approach), table 5 presents the results when I include sector dummies interactions with the endogenous

variable ’inefficiency’ (here I denote by ’High.inefficiency’ the interaction term of the high tangibility

23
dummy and the inefficiency measure, the same applies to ’Low.inefficiency’, but for the low tangibility
4
dummy). The point estimate presents a higher impact on the labour force for firms operating in the

high tangibility sector, although the effects are not statistically different. For the wage variable, the

result continues to be insignificant.

Table 5: Estimation with the first tangibility classification

1
∆ hourly wage ∆ labour force
High.inefficiency -0.1876 −91.34∗∗∗
[0.1556] [25.5]
Low.inefficiency -0.148 −64.14∗∗∗
[0.1384] [23.37]
log(avg neigh pop) −0.1097∗∗∗ 0.218
[0.0177] [3.22]
constant 3.654∗∗∗ 502.9∗∗∗
[1.057] [168.1]
No. observations 30261 30261
Fixed effect: State,Sector State, Sector
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01
1 in thousands

The second approach (the asset hardness approach) results are described in table 6. Firms operating

in a high tangibility sector observed a higher increase in their labour force; the low tangibility result

for this measure of tangibility is not significant. The wage variable presents a different behaviour from

the previous ones; the impact is significant for the two sectors and positive.

4 When I include the dummies interaction with the (inef f ) variable, the instruments are taken to be (High).(Potential

extra-jurisdiction) and (Low).(Potential extra-jurisdiction), that is, the instruments now are the interaction of the tan-
gibility dummies with the previous instrument, the number of potential extra-jurisdiction

24
 Table 6: Estimation with the second tangibility classification

∆ hourly wage ∆ labour force

High.inefficiency 0.2651∗ −470.92∗
[0.1374] [282.25]
Low.inefficiency 0.4058∗∗∗ -481.89
[0.1344] [354.81]
log(avg neigh pop) −0.1321∗∗∗ 67.99
[0.0259] [75.1]
capital intensity 25.028∗∗∗ -2959.1
[2.4148] [19700.1]
constant -0.0479 2321.4
[1.0132] [2072.8]
No. observations 57749 57749
Fixed effect: State State
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01

7 Conclusion

This research derived an empirical model to better understand the impact of the bankruptcy reform

on labour market. The identification of the effect followed the strategy first described in Ponticelli and

Alencar (2016), exploring the fact that, in Brazil, municipalities must reach minimum requirements to

be eligible to posses a court. For a municipality which is a seat of a judicial district, the measure of

neighbouring municipalities which do not meet the minimum requirements correlates positively with

its judicial inefficiency. This measure of potential extra-jurisdiction is exogenous, once I accounted

for observable variables which determine the eligibility of a municipality to posses a court. I applied

an instrumental variable approach to study the structural effect of the new law and judicial efficiency

on the labour market, where the instrument for the efficiency measure is the number of neighbouring

municipalities without a court of their own.

Two measures of asset tangibility were introduced, allowing the empirical specifications to study het-

erogeneous effects between different sectors, classified by those tangibility measures.

The results point in the expected direction: there seems to be a labour transition from the sectors less

benefited by the new law to the more benefited ones, that is, after the reform, municipalities with a

more efficient judicial system observed an increase in their labour force and the effect was stronger on

sectors which employ more tangible assets.

I also observed that, after the reform, municipalities with a more efficient judicial system experienced

25
a higher increase in wages, although the result is not statistically significant. All those results are

consistent with the simple conceptual model described in the text. The final mechanism that I tested

is the homogeneity of the effect on wages, across sectors. The conceptual model did not allow for

heterogeneity of wages between sectors, thus I wanted to test if this assumption is unrealistic.

For the first tangibility measure, the results were as expected: the sign of the effect of judicial inef-

ficiency on wages was negative on both sectors and there was no statistically significant difference of

wage change between sectors. For the second tangibility measure, there was no statistically significant

difference of wage change between sectors, although the signs were positive, that is, contrary to the

expected. This unexpected result suggests that the effects on wages should be further studied, possibly

applying empirical specifications at the worker’s level.

26
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29
8 Appendix

8.1 A possible extension

The two empirical specifications that were presented in the text are looking at firm’s decision on labour

force. Here, I present an alternative empirical model that could focus on the worker side. As described

in the model section, I assume that the total labour supply is fixed, but not the composition between

sectors. From a worker’s perspective, after the reform it should be easier to end up working for a firm

with more tangible assets.

Denote by pi,t,sp ,sq the probability that a worker i from sector sp on time t starts working on sector

sq next period. Then a system of equations for every pair sq , sp could be stated as 16

pi,t,sp ,sq = αi + αt + βsp ,sq (ref )t .(inef f )j + i,t (16)

where: (ref )t is a dummy variable, equal zero on the pre-reform period and equal to one after; (inef f )j

is the inefficiency of the judicial system on the location of the worker’s job j; αi is a fixed effect at the

worker’s level. The system in 16 can be seen as describing the flow of workers between sectors. The

model described in section (1) implies that βsp ,sq < 0 if sector sq has more tangible assets than sector

sp , and βsp ,sq > 0, otherwise.

Taking the first difference, I obtain equation 17

∆pi,sp ,sq = α + βsp ,sq .(inef f )j + i (17)

In this specification I could follow a worker and see if the results are more significant for those workers

who have changed sector.

8.2 Additional tables

Table 8 presents the results when included a year dummy interacted with the endogenous measure

of inefficiency. The labour force effect is significant and negative for all years considered. For the

dependent variable ’wages’, the results for 2006-2007 are negative and statistically significant, while

30
 Table 7: Second stage regression with the second classification for tangibility

∆ hourly wage ∆ labour force1

Inefficiency 0.4050∗∗∗ -482.71
[0.1381] [354.97]
log(avg neigh pop) −0.1234∗∗∗ 66.83
[0.0262] [69.06]
Tangibility −1.7153∗∗∗ -494.52
[0.5403] [662.68]
Capital intensity −19.23∗∗∗ -372.95
[2.4893] [11020]
constant 0.1450 2397.7
[1.0346] [2170.4]
No. observations 57749 57749
Fixed effect: State State
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01

the sign changes in 2008 and becomes insignificant in 2009. Thus, the effects are as expected for wages

until 2008. Firms operating in municipalities with a more efficient judicial system observed an increase

in their labour force and wages.

Table 8: Second stage by year with first tangibility classification

1
∆ hourly wage ∆ labour force
2006.ineff −0.2009∗∗ −19.23∗∗∗
[0.096] [5.146]
2007.ineff −0.1749∗ −19.08∗∗∗
[0.0958] [5.149]
2008.ineff 0.3326∗∗∗ −19.37∗∗∗
[0.0934] [5.147]
2009.ineff -0.0259 −19.32∗∗∗
[0.0958] [5.1487]
log(avg neigh pop) −0.0831∗∗ 10.43∗∗∗
[0.0366] [3.772]
constant 2.4389∗∗∗ 7.074
[0.7718] [40.33]
No. observations 121044 121044
Fixed effect: State,Sector State, Sector
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01
1 in thousands

The same results folow when I apply the second tangibility classification, as presented in table 9

I can repeat the exercise of estimating the second stage for the first approach, while interacting the

31
 Table 9: Second stage by year with second tangibility classification

∆ hourly wage ∆ labour force

2006.ineff 0.2168∗∗ −810.0∗
[0.1017] [452.97]
2007.ineff 0.2445∗∗∗ −801.89∗
[0.1016] [452.83]
2008.ineff 0.7865∗∗∗ −861.0∗
[0.1007] [452.33]
2009.ineff 0.4060∗∗∗ −865.23∗
[0.1012] [452.17]
log(avg neigh pop) −0.1337∗∗∗ 102.56
[0.0182] [88.114]
constant 0.0748 4339.7
[0.7637] [2683.4]
No. observations 230996 230996
Fixed effect: State State
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01

variables with year dummies. Table 10 presents the results. The labour force results are consistent

across all years. The high tangibility sector observed an increase in its labour force when located

in a more judicially efficient municipality. The low tangibility sector observed a lower impact. The

behaviour of the wage variable is similar to the one observed in table 8. The effect is negative for 2006

and 2007, on both sectors; then it changes sign and becomes insignificant in 2009.

Finally, I repeat the estimation with year dummies for the second approach, as presented in table 11.

Breaking the results year by year enlarges the standard errors on the labour force regression, such

that the statistical significance is lost. For the wage variable, the results continue being positive and

significant.

32
 Table 10: Estimation with tangibility and year dummies

1
∆ hourly wage ∆ labour force
2006.High.ineff −0.2623∗∗ −33.03∗∗∗
[0.1108] [7.909]
2006.Low.ineff −0.1684∗ −10.35∗
[0.0905] [5.681]
2007.High.ineff −0.2447∗∗ −32.92∗∗∗
[0.1108] [7.91]
2007.Low.ineff -0.1383 −10.18∗
[0.0904] [5.68]
2008.High.ineff 0.4429∗∗∗ −33.3∗∗∗
[0.1099] [7.912]
2008.Low.ineff 0.2827∗∗∗ −10.43∗
[0.0882] [5.678]
2009.High.ineff -0.0802 −33.3∗∗∗
[0.1108] [7.912]
2009.Low.ineff 0.0033 −10.38∗
[0.0904] [5.678]
log(avg neigh pop) −0.0830∗∗ 10.52∗∗∗
[0.0375] [3.831]
constant 2.5081∗∗∗ 58.06
[0.8281] [58.85]
No. observations 121044 121044
Fixed effect: State,Sector State, Sector
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01
1 in thousands

33
Table 11: Estimation with second tangibility measure and year dummies

∆ hourly wage ∆ labour force

2006.High.ineff 0.0690 -489.89
[0.1060] [365.49]
2006.Low.ineff 0.1916∗ -459.56
[0.1042] [470.29]
2007.High.ineff 0.0912 -487.05
[0.1060] [365.5]
2007.Low.ineff 0.2147∗∗ -449.79
[0.1042] [470.26]
2008.High.ineff 0.6164∗∗∗ -491.27
[0.1061] [365.51]
2008.Low.ineff 0.7865∗∗∗ -544.89
[0.1030] [470.07]
2009.High.ineff 0.2423∗∗ -490.73
[0.1060] [365.51]
2009.Low.ineff 0.3806∗∗∗ -556.56
[0.1033] [470.01]
log(avg neigh pop) −0.1316∗∗∗ 69.98
[0.0188] [98.825]
capital intensity 24.717∗∗∗ -3498.3
[1.9609] [26300]
constant 0.0142 2442.9
[0.7697] [2753.1]
No. observations 230996 230996
Fixed effect: State State
Robust standard errors in brackets
* p<.1, ** p<.05, ***p<.01

34
Table 12: Minimum requirements - potential extra-jurisdiction threshold

State Minimum population

AC 4,000
AL 10,000
AP 5,000
BA 20,000
CE 10,000
ES 20,000
GO 20,000
MA 20,000
MG 18,000
MS 10,000
MT 10,000
PA 5,000
PB 20,000
PE 20,000
PI 10,000
PR 30,000
RJ 15,000
RN 10,000
RO 10,000
RR 8,000
RS 20,000
SC 20,000
SE 30,000
SP 10,000
TO 21,000
Source: adapted from
Ponticelli and Alencar (2016)

35