Bankruptcy Law and Firms' Behavior

Abstract

The aim of this paper is to study the impact of bankruptcy law on financing, investment, default and liquidation decisions of firms. We build a model in which a firm can finance its investment by issuing debt. The investment is risky. Because of risk, the firm may default. The firm manager takes investment and default decisions in order to maximize the value of equities. Before investment takes place, shareholders and bondholders bargain over the share of the investment that is financed trough debt and the annual coupon. If it occurs, at default the firm enters an observation period after which the decision of liquidation or continuation is taken. The model is solved and calibrated in order to reproduce French firms characteristics. We then study the effect on financing, investment, default and liquidation decisions of the firms, of changes in the parameters that summarize the bankruptcy procedure.

Keywords: Bankruptcy, capital structure, investment, real options

JEL Classification: G12, G32, G33