Matching Bankruptcy Laws to Legal Environments

We study a model of optimal bankruptcy law in an environmentwhere legal quality can vary along two dimensions: the expertiseof judges and the quality of contract enforcement. We analyzea model in which a judicially influenced bankruptcy processcan enhance the efficiency of incomplete contracts by conditioningthe allocation of control rights in bankruptcy on firm quality.We consider the optimal balance of debtor and creditor interestsas a function of the legal environment and show that the optimaldegree of "creditor-friendliness" in the bankruptcy code increasesas judicial ability to recognize firm quality falls and as thequality of contract enforcement deteriorates. Our model showsthat a bankruptcy law that attempts to preserve going-concernvalue, such as US Chapter 11, requires judicial expertise tobe effective. Where such expertise is unavailable, a law thatfocuses more on creditor recovery is preferred. (JEL D86, G33,G34, K22)     

Severe or gentle bankruptcy law: Which impact on investing and financing decisions?

This research investigates how legal sanctions prevailing under bankruptcy may impact on debt contracting and on investing decision. We model firms having the opportunity to engage (or not) faulty management. In case of default, the firms may escape costly bankruptcy by reaching a private agreement with the bank. We show that such renegotiation process may depend on the level of severity of bankruptcy law.Our approach helps in answering the following key questions: can bankruptcy costs always be internalized? Who benefits from accrued severity? Should the creditors accept a certain level of moral hazard from their debtors? Should bankruptcy law be extremely severe in order to ensure ex-ante efficiency? Does such severity depend on the financial environment?The model focuses on three equilibriums. The first equilibrium describes honest firms that choose the best investment project (ex-ante efficiency). Here, we show that bankruptcy costs can be avoided through private renegotiation (ex-post efficiency). Yet, the legislator cannot directly implement this equilibrium as it does not depend on the level of legal sanctions. A second equilibrium describes tricky firms turning to the less profitable and riskiest project. Here, default is still privately resolved: the occurrence of such equilibrium can be avoided owing to a minimal amount of legal sanctions that depend on the level of interest rate. Last, we consider firms that adopt mixed strategies regarding their investment policy. Here, two post-default bargains prevail (pooling or separating) and costly bankruptcy may occur.Simulations illustrate how the bank finally chooses between these equilibriums while the legal environment becomes more severe. For moderate levels of legal sanctions, banks may accept a certain level of faulty management, expecting to take advantage of bankruptcy punishment. An increase in sanctions, however, has a compelling effect on the companies towards honoring their commitments. Once the optimal equilibrium prevails, any additional increase in sanctions is ineffective as the players' strategies no longer depend on the legal environment. As a result, extreme severity is not required to ensure both ex-ante and ex-post efficiencies. Last, we find that a more severe bankruptcy law increases the protection of banks and may result in reduction of the contractual interest rate, which on the other hand benefits the debtors.     

Optimal personal bankruptcy design under moral hazard

In this paper, we develop a normative theory of unsecured consumer credit and personal bankruptcy based on the optimal trade-off between incentives and insurance. First, in order to characterize this trade-off, we solve a dynamic moral hazard problem in which agents' private effort decisions influence the life-cycle profiles of their earnings. We then show how the optimal allocation of individual effort and consumption can be implemented in a market equilibrium in which (i) agents and intermediaries repeatedly trade secured and unsecured debt instruments, and (ii) agents obtain (restricted) discharge of their unsecured debts in bankruptcy. The structure of this equilibrium and the associated restrictions on debt discharge closely match the main qualitative features of personal credit markets and bankruptcy law that actually exist in the United States.     

Has Anything Changed in the Past Century? Revisiting Graue's "The Social Cost of Bad Debt"

In a seminal paper, Erwin Graue (1939) provides an institutional analysis of the causes and consequences of personal bankruptcy protection in the United States during the period 1900-1937 when bankruptcy procedures were guided by the Federal Bankruptcy Act of 1898 (the Law was revised in 1938). This paper revisits the Graue study in the context of the current recession using a simple institutional economic framework. Consistent with Graue, we begin shortly after the implementation of the Bankruptcy Abuse Protection and Consumer Protection Act of 2005 (BAPCPA) and follow its evolution to the present time. Our analysis suggests that, since passage of BAPCPA, both total filings and Chapter 7 filings decreased significantly, however temporarily. Moreover, Chapter 7 filings as a percentage of Chapter 13 filings also temporarily decreased. These results are not only consistent with Graue's analysis, but also demonstrate that the institutional characteristics of bankruptcy law have a profound impact on the decision to file for bankruptcy and the chapter under which a petitioner files.     

Leaving your tailings behind: Environmental bonds,bankruptcy and waste cleanup

This paper studies the impacts of an environmental bond, which fully covers waste cleanup costs, on a mining firm's optimal actions over the full life cycle of a mine, when bankruptcy may shift cleanup costs to the government. A firm's stochastic optimal control problem is described by an HJB equation with the resource price modelled as an Ito process. A theoretical result shows that under certain assumptions, an environmental bond can ensure that the option to declare bankruptcy has no impact on the firm's optimal actions. A numerical solution is implemented for a hypothetical copper mine using two different models of bankruptcy risk. Numerical results show that when bankruptcy is an option and no bond is required, the firm produces too much waste relative to a benchmark case, resulting in an efficiency loss and a cleanup liability imposed on government. In the presence of bankruptcy risk, a bond ensures that the firm acts optimally and no efficiency loss is imposed on society.     

Information and credit access: using bankruptcy as a signal

Legally, a bankruptcy flag can appear on an individual's credit report for up to 10 years after the filing. The flag affects an individual's credit score, and in turn, an individual's access to credit. In this article, we investigate how the bankruptcy flag affects access to credit along three dimensions–loan acceptance, the price of the loan as is determined by the interest rate, and the amount of credit the household receives. Using the Panel Study of Income Dynamics and the Survey of Consumer Finances, we estimate a series of two-stage models corrected for sample selection and adjusted to account for the household's level of creditworthiness. We find that the bankruptcy flag increases the probability of being denied access to a loan. The flag also increases interest rates for unsecured loans and lowers the credit limits available to households. The findings have important implications with respect to current bankruptcy code and the impact that information, such as the bankruptcy flag, can have on the efficiency of the credit markets.     

Counterparty effects on capital structure decision in incomplete market

This paper builds a static contingent-claim model that allows for examining the optimal capital structure with the joint arguments of counterparty default risk and market incompleteness. A first-passage-time model with jump default barrier is adopted to capture the counterparty effects on the pricing of defaultable claims. Following the framework of Jarrow and Yu (2001), the jump in primary firm's bankruptcy barrier is designed as the loss on capital resulted from secondary firm's bankruptcy. The relevance of market incompleteness in the context of claim-pricing is considered using “good-deal asset price bound” method by Cochrane and Saa-Requejo (2000). We show that the effects of counterparty's default clearly diminish the uses of debt, which indirectly explains the so-called under-leveraged puzzle. We further find that counterparty effects on capital structure are sensitive to market incompleteness and firm's characteristics, such as tax rate and bankruptcy cost rate.     

个人信用与个人破产制度法律关系的分析——兼论我国建立个人破产制度的现实意义

目前,我国个人信用市场存在大量支付不能的债务无法通过现行法律妥善清理,导致个人信用风险难以得到有效控制和化解.本文从分析个人信用的法律保护入手,重点从内在逻辑联系以及个人破产制度的规则安排与个人信用的动态维护两方面,对个人信用和个人破产的法律关系进行了深入探讨,进而论证当前我国建立个人破产制度、推动个人信用风险管理的现实意义.     

On the welfare implications of restricting bankruptcy information

The Fair Credit Reporting Act (FCRA) dictates that adverse events such as a Chapter 7 bankruptcy filing must be removed from an individual’s credit record after 10 years. The intent of the law is to provide partial consumption insurance by giving an individual a fresh start. However, the law obviously weakens incentives not to default, which can result in higher interest rates that in turn reduce intertemporal insurance. Because of this tradeoff, it is unclear how long is the optimal length of time that an adverse event remains on an individual’s credit record. In this paper we assess the welfare consequences of varying the length of time that adverse events can be on one’s credit record. We calibrate the model to US data where the exclusion parameter is set to be 10 years on average. Then we run a counterfactual to find the length that maximizes ex-post economywide welfare using a consumption equivalent measure. The model predicts agents prefer to remove the bankruptcy flag after one year, though the gains are small.     

Managerial compensation and the underinvestment problem

This paper studies the effect of managerial compensation terms on the well-known “underinvestment” incentive. We extend the Mauer and Ott (2000) real-option model of corporate expansion, and show that, when the manager maximizes the value of his compensation package (rather than equity value), the underinvestment problem can be substantially mitigated. Further, by designing an appropriate compensation contract, it is possible to eliminate the underinvestment incentive altogether. This managerial contract, consisting of fixed salary and equity ownership, is explicitly derived in the model. The equity ownership level is found to be an increasing function of the manager's fixed salary and the company's earnings growth rate, and a decreasing function of leverage ratio, earnings volatility, tax rate, bankruptcy costs, and the manager's severance pay at bankruptcy.     

The impact of personal bankruptcy law on entrepreneurship

I study the two competing effects of limited personal liability on entrepreneurship in a life‐cycle model: an insurance effect through debt relief in the event of business failure and a borrowing cost effect where the borrowing cost rises with default premiums. I first calibrate the model to the US economy by taking a simplified version of the US Chapter 7 bankruptcy code and then consider the effects of alternative regimes. I find that personal bankruptcy law affects entrepreneurship primarily by altering the decisions of agents with moderate entrepreneurial ability through the insurance effect rather than through the borrowing cost effect.     

Bankruptcy and Entrepreneurship: The Value of a Fresh Start

This article considers bankruptcy law design in a setting thatis appropriate for entrepreneurial firms. These firms are characterizedby a dependence on an owner-manager who is essential to thefirm and must be given incentive through an ownership staketo maximize the value of the project. In a relationship-lendingenvironment, the banks that fund entrepreneurs cannot capturethe gains from providing the entrepreneur with this stake, andthis leaves the entrepreneur emerging from bankruptcy with alarger debt burden than is socially efficient. In this setting,a "fresh-start" bankruptcy policy provides greater debt reliefthan the bank would approve voluntarily, and this generatesgreater social surplus. The results suggest the value of separateprocedures for small business bankruptcies that allow some mandatorydebt relief to preserve ex post incentives.     

Financial institutions and the financial crisis in East Asia

This paper investigates institutional reasons for the soft-budget constraint problem; and how the soft-budget constraint problem creates conditions which may result in a financial crisis. As a consequence of soft-budget constraints, bad projects do not stop; bad loans accumulate; and banks and depositors do not receive bad news on time. Poorly informed depositors are then likely to herd to overinvest when there is no bankruptcy (`frenzy'); and they are likely to herd to panic when bankruptcy occurs (`crash'), which may be the result of excessive bad loans that are also a consequence of soft-budget constraints. In contrast, under hard-budget constraints information is disclosed quickly regarding liquidation. Better-informed investors are then less likely to herd wrongly.     

从古桥的无奈看国有企业的市场退出

目前,国有企业在退出市场过程中要面对经济、体制、感情等多方面的障碍。为此,国有企业退出市场时,在防止国有资产流失的前提下,要实施管理创新,变被动退出为主动退出;政府要加强宏观控制,降低企业退出成本,为劣势企业顺利退出市场创造宽松的环境和条件,形成企业有进有退的市场机制。     

Bankruptcy voting process and corporate reorganization

This study investigates the main legal determinants of corporate reorganization use. Three legal aspects of bankruptcy voting process were examined, such as the voting right of secured creditors (1), bankruptcy voting rule (2), and court's legal right to overrule creditors’ decision (3). Using a sample of 20 countries, our estimations confirm that granting a voting right to secured lenders tends to be associated with more corporate reorganizations. Secured creditors’ voting right may send a signal about firm's capacity to recover from financial distress. Such signal can encourage unsecured creditors to support the reorganization plan.     

SOCIAL INFLUENCE AND THE CONSUMER BANKRUPTCY DECISION

I examine the influence of neighbors on the consumer bankruptcy decision using administrative bankruptcy records linked to the 2000 Decennial Census. Two empirical strategies remove unobserved common factors that affect identification. The first strategy uses small geographical areas to isolate neighborhood effects, and the second strategy identifies the effect using past bankruptcy filers who moved states. The findings from both strategies reinforce each other and confirm the role of social influence on the bankruptcy decision. Having a past bankruptcy filer move into the block from a different state increases the likelihood of filing by 10%. (JEL D12, K35)     

Do liquidity constraints generate excess sensitivity in consumption? New evidence from a sample of post-bankruptcy households

Previous work linking liquidity constraints to excessive consumption sensitivity have used household level information on wealth and assets to split the sample into households that are likely to be constrained from those with access to credit and liquidity. In this paper, we use the sample splitting methods of previous authors but refine the criteria by using direct information on whether the household filed for bankruptcy in the last 10 years. Legally, a flag can appear on a bankruptcy filer’s credit report for up to 10 years after bankruptcy. This bankruptcy flag affects an individual’s credit score, and therefore the individual’s access to credit, which may make post-bankruptcy consumers liquidity constrained. Our results indicate that post-bankruptcy consumers exhibit excess sensitivity likely due to the bankruptcy flag. Consistency checks confirm that the source of sensitivity is due to liquidity constraints and not other observationally equivalent behavior.     

破产重整与破产和解程序之比较

作为破产预防的程序机制，重整与和解有许多相同之处，但是二者在价值层面和制度层面存在诸多差异，尤以价值层面差异为最。重整与和解各有优缺点，唯有两者同时存在，并互为补充，才有利于使破产法体系更臻于完善，更接近法律所致力追求的公平与正义。     

Early warning models against bankruptcy risk for Central European and Latin American enterprises

This article is devoted to the issue of forecasting the bankruptcy risk of enterprises in Latin America and Central Europe. The author has used statistical and soft computing methods to program the prediction models. It compares the effectiveness of twelve different early warning models for forecasting the bankruptcy risk of companies. In the research conducted, the author used data on 185 companies listed on the Warsaw Stock Exchange and 60 companies listed on Stock Exchange markets in Mexico, Argentina, Peru, Brazil and Chile. This population of firms was divided into learning and testing setdata. Each company was analyzed using the absolute values of 14 financial ratios and the dynamics of change of these ratios.The author's developed models are characterized by high efficiency. These studies are one of the world's first attempts at comparing differences in forecasting this phenomenon between the regions of Latin America and Central Europe. Additionally, a comparison of the effectiveness of discriminant analysis, decisional trees, and artificial neural networks models was made.     

How employment insurance recipients make decision about insolvency?

Beyond the maximum insurable income, the size of the shortfall increases with the worker's income, leaving unemployed workers with little or no room to maintain a decent life while meeting all their other obligations. This situation is even more perilous in an indebted society where the debt per income ratio hovers at around 175%. This paper contributes to the literature by identifying the key socioeconomic and demographic indicators that dictate the insolvency choice (bankruptcy or consumer proposal) of Canadian insolvent employment insurance recipients. Using Canadian data, we show that low employment insurance leads debtors to eat up their asset and incur more debt, which ultimately make bankruptcy more appealing to them than proposal.