Bankruptcy Law and Corporate Investment Decisions

TILEC Discussion Paper No. 2009-040

CentER Discussion Paper Series No. 2009-86

29 Pages Posted: 24 Oct 2009 Last revised: 4 May 2011

See all articles by Emanuele Tarantino

Emanuele Tarantino

University of Mannheim - Department of Economics; Tilburg Law and Economics Center (TILEC)

Multiple version iconThere are 2 versions of this paper

Date Written: April 2011

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 (April 2011). TILEC Discussion Paper No. 2009-040. Available at SSRN: https://ssrn.com/abstract=1493211 or http://dx.doi.org/10.2139/ssrn.1493211

Emanuele Tarantino (Contact Author)

University of Mannheim - Department of Economics ( email )

D-68131 Mannheim
Germany

Tilburg Law and Economics Center (TILEC) ( email )

Warandelaan 2
Tilburg, 5000 LE
Netherlands

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