Bankruptcy Law and Corporate Investment Decisions

29 Pages Posted: 18 Mar 2009 Last revised: 24 Apr 2011

See all articles by Emanuele Tarantino

Emanuele Tarantino

Luiss Guido Carli University; Einaudi Institute for Economics and Finance (EIEF)

Multiple version iconThere are 2 versions of this paper

Date Written: May 26, 2010

Abstract

Major European countries have recently adopted bankruptcy codes that strengthen entrepreneurs' power to renegotiate outstanding liabilities. Renegotiation in bankruptcy allows lenders to increase recovery rates, however it also weakens the contract's ability to solve the repeated moral hazard problem embedded in the production project. Hinging on this basic trade-off, I show in which circumstances a soft bankruptcy law that resembles Chapter 11 in the balance of lenders' and entrepreneur's rights encourages the choice of investments that privilege the achievement of long-term results. However, I also show that, in contrast to the common wisdom, soft bankruptcy can lead to the choice of investments that are biased towards the achievement of short-term outcomes.

Keywords: Bankruptcy Law, Financial Contracts, Limited Commitment, Soft budget constraint, Short-termism

JEL Classification: D82, G33, K22

Suggested Citation

Tarantino, Emanuele, Bankruptcy Law and Corporate Investment Decisions (May 26, 2010). Available at SSRN: https://ssrn.com/abstract=1362566 or http://dx.doi.org/10.2139/ssrn.1362566

Emanuele Tarantino (Contact Author)

Luiss Guido Carli University ( email )

Via O. Tommasini 1
Rome, Roma 00100
Italy

Einaudi Institute for Economics and Finance (EIEF) ( email )

Via Due Macelli, 73
Rome, 00187
Italy

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