Busy Bankruptcy Courts and the Cost of Credit

Abstract

How large are the welfare losses from inefficient debt enforcement? This paper studies the 2005 consumer bankruptcy reform, which generated the largest recorded drop in the caseload of bankruptcy courts in the United States. The law fundamentally changed individual bankruptcies but left corporate filings unaffected. This allows me to quantify the effect of debt enforcement on firms’ loan terms, holding the legal framework constant. I find that lower court congestion is priced into credit spreads and loan maturities, particularly for risky firms. The evidence suggests that creditors learn about recovery values in close to real-time and adjust debt contracts accordingly.

Keywords: bankruptcy, courts, debt enforcement, law and finance

JEL Classification: G21, G32, G33, K22, K42.