Does weak contract enforcement affect firm size? Evidence from the neighbour’s court

Abstract

Poor contract enforcement can importantly affect firms’ incentives to grow. We investigate the causal effect of the weakness of contract enforcement on average firm size across Italian municipalities, exploiting spatial discontinuities in court jurisdictions for identification. Italy provides an ideal environment for this exercise, as it displays wide variation in judicial efficiency across courts, while the allocation of municipalities to jurisdictions is a historical legacy and does not overlap with other political or economic discontinuities. Our estimates indicate that reducing the length of judicial proceedings (i.e. improving contract enforceability) by 10% at court level leads to a 2% increase in average size of local firms. The outcome on turnover growth is of the same magnitude, suggesting that the effect operates at the intensive margin.