Bankruptcy and firm finance |
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Authors: | Stefan Krasa Tridib Sharma Anne P Villamil |
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Institution: | (1) Department of Economics, University of Illinois, 1206 S. 6th Street, Champaign, IL 61820, USA;(2) Centro de Investigación Económica, ITAM, Ave. Camino Santa Teresa #930, Mexico D.F, 10700, Mexico |
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Abstract: | This paper analyzes how an enforcement mechanism that resembles a court affects firm finance. The court is described by two
parameters that correspond to enforcement costs and the amount of creditor/debtor protection. We provide a theoretical and
quantitative characterization of the effect of these enforcement parameters on the contract loan rate, the default probability
and welfare. We analyze agents’ incentive to default and pursue bankruptcy and show that when the constraints that govern
these decisions bind, the enforcement parameters can have a sharply non-linear effect on finance. We also compute the welfare
losses of “poor institutions” and show that they are non-trivial. The results provide guidance on when models which abstract
from enforcement provide good approximations and when they do not.
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Keywords: | Enforcement Default Bankruptcy Legal environment Contracts Limited commitment Debt Creditor protection Inflation |
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