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The Bright Side of Foreign Competition: Import Penetration and Default Risk

We examine the effect that foreign competition has on firms’ default risk, and document a strong and robust negative association. Utilizing a large sample of public U.S. manufacturing firms and industry-level import penetration data, we find that an increase in import penetration from the 25th to the 75th percentile leads to a reduction in corporate default risk of roughly 15.5%. These results hold after accounting for potential endogeneity concerns. We also document a negative association between import penetration and the incidence of bankruptcy as well as the incidence of covenant violations. Further tests reveal that the negative association between import penetration and default risk is most pronounced for firms that lax managerial oversight, suggesting that foreign competition is a substitute for effective corporate governance. Our paper contributes to the ongoing discourse on the costs and benefits of trade liberalization, documenting the ‘bright side’ of foreign competition.