31 Pages Posted: 1 Aug 2006
Date Written: August 7, 2006
Amidst a sharp increase in household debt levels, many countries have substantially reformed their consumer bankruptcy regulations. I first classify the mechanisms triggered by current U.S. and European bankruptcy regulations and then evaluate these mechanisms within a hidden action model. I analyze the consumer's incentives prior to distress and during a "period of good conduct" following bankruptcy, appraising the capacity of existing regulations to implement those conflicting objectives. Though the institution of debt release provides adequate bankruptcy regulation ex-post, the prospect of debt release also distorts the debtor's choices prior to distress. I propose alternative regulations that provide superior incentives, minimizing the overall distortions at both dates. A numerical example illustrates the findings.
Keywords: Personal Bankruptcy, Limited Liability, Moral Hazard, Law & Economics
JEL Classification: D18, D91, K35, G33
Suggested Citation: Suggested Citation