Should Courts Enforce Credit Contracts Strictly?
Università Politecnica delle Marche - Faculty of Economics
Economic Journal, Vol. 115, No. 500, pp. 166-184, January 2005
The intimate linkages between law and finance are currently the centre of wide-ranging empirical investigations. This article presents a simple banking model with information asymmetries concerning borrowers' entrepreneurial talent. It is shown that improvements in the enforcement of contract by courts reduce agency problems but can also reduce the bank's incentive to screen borrowers adequately, thus worsening credit allocation. A stricter enforcement of credit contracts, therefore, may be socially harmful even if costlessly achieved. Improvements in accounting standards, however, always make bank screening of borrowers less costly and improve credit allocation and social welfare.
Number of Pages in PDF File: 19Accepted Paper Series
Date posted: December 28, 2004
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