The Real Effects of Judicial Enforcement

This paper shows that the quality of judicial enforcement has substantial real effects. I exploit a reorganization of the judicial districts in Italy as an exogenous shock to court productivity and, using an instrumental variable approach, estimate an elasticity of employment to average trial length between -0.36 and -0.29. These results are very different from OLS estimates which do not control for endogeneity. Firms with low asset tangibility, high uncertainty, and headquartered in areas with low social capital appear to respond more to changes in the legal environment. The effects are also more pronounced in highly levered and more financially dependent firms, suggesting that weaker law enforcement tightens financing constraints, and appear to affect mainly firms in less financially developed areas. I obtain similar results for revenues and total compensation. There is, instead, a positive relationship between average wages and trial length, possibly because workers demand compensation for bearing risk due to financing constraints. These results offer a more complete picture of the interplay between legal institutions and real economic outcomes.