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Matching Bankruptcy Laws to Legal Environments

33 Pages Posted: 4 Nov 2004  

Kenneth Ayotte

University of California, Berkeley - School of Law

Hayong Yun

Michigan State University - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: February 16, 2006

Abstract

We study a model of optimal bankruptcy law in an environment where legal quality can vary along two dimensions: the ability of judges, and the quality of contract enforcement. We analyze a model in which a judicially-influenced bankruptcy process can enhance the efficiency of incomplete contracts by conditioning the allocation of control rights in bankruptcy on firm quality. We consider the optimal balance of debtor and creditor interests as a function of the legal environment, and show that the optimal degree of "creditor-friendliness" in the bankruptcy code increases as judicial ability to recognize firm quality falls and as the quality of contract enforcement deteriorates. Our model contributes to the existing bankruptcy law design literature in demonstrating that a "debtor-friendly" law that focuses on preserving going-concern value, such as U.S. Chapter 11, requires judicial expertise to be effective. Where such expertise is unavailable, a law that focuses more on creditor recovery is preferred. Our model is also able to explain cross-country patterns in the content and usage of bankruptcy laws around the world as reported in existing empirical research.

Keywords: Bankruptcy, investor protection, law and finance

JEL Classification: G33, G38, K00

Suggested Citation

Ayotte, Kenneth and Yun, Hayong, Matching Bankruptcy Laws to Legal Environments (February 16, 2006). Available at SSRN: https://ssrn.com/abstract=613641 or http://dx.doi.org/10.2139/ssrn.613641

Kenneth Ayotte (Contact Author)

University of California, Berkeley - School of Law ( email )

215 Boalt Hall
Berkeley, CA 94720-7200
United States

Hayong Yun

Michigan State University - Department of Finance ( email )

645 N Shaw Lane, Room 339
East Lansing, MI 48824-1122
United States
517-884-0549 (Phone)

HOME PAGE: http://https://sites.google.com/site/hayongy/

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