Crisis Interventions in Corporate Insolvency
73 Pages Posted: 16 Feb 2021 Last revised: 5 Nov 2021
Date Written: November 4, 2021
We model the optimal resolution of insolvent firms in general equilibrium. Privately optimizing agents choose to let banks assign liquidations, encouraging ex-ante lending. A social planner optimally intervenes during a crisis because of two pecuniary externalities. A fire-sale externality motivates subsidies for liquidation-preventing loans to insolvent firms. However, a loan-price externality arises when constrained banks allocate scarce capital to averting liquidations rather than bolstering healthier firms, motivating liquidation subsidies. Efficient intervention can thus encourage or discourage liquidation, depending on the crisis, shedding light on recent crisis-motivated policy proposals. Interventions in seniority structures can substitute for interventions in liquidation decisions.
Keywords: Corporate Insolvency, Bankruptcy, Crisis Intervention, Pecuniary Externality, Zombie Lending
JEL Classification: D62, G28, G33, G38
Suggested Citation: Suggested Citation