Research on Resolving Insolvency

Bankruptcy Auctions: Costs of Debt Recovery and Firm Survival

Karin Thorburn

This paper provides some first, large-sample evidence on the Swedish auction bankruptcy system. Compared to U.S. Chapter 11 cases, the small-firm bankruptcy auctions examined here are substantially quicker, have lower costs, and avoid deviations from absolute priority. Three-quarters of the firms are auctioned as going concerns, which is similar to Chapter 11 survival rates. Moreover, based on market values, creditors in going-concern auctions recover a similar fraction of face value as creditors of much larger firms in Chapter 11 reorganizations. The evidence presented here suggests that the auction bankruptcy system is a surprisingly efficient restructuring mechanism for small firms.

Conflicts of Interest and Market Illiquidity in Bankruptcy Auctions: Theory and Tests

Per Stromberg

I develop and estimate a model of cash auction bankruptcy using data on 205 Swedish firms. The results challenge arguments that cash auctions, as compared to reorganizations, are immune to conflicts of interest between claimholders but lead to inefficient liquidations. I show that a sale of the assets back to incumbent management is a common bankruptcy outcome. Sale-backs are more likely when they favor the bank at the expense of other creditors. On the other hand, inefficient liquidations are frequently avoided through sale-backs when markets are illiquid, that is, when industry indebtedness is high and the firm has few nonspecific assets.

Credit, Wages, and Bankruptcy Laws

Bruno Biais and Thomas Mariotti

We analyze how bankruptcy laws affect the general equilibrium interactions between credit and wages. Soft laws reduce the frequency of liquidations and thus ex post inefficiencies, but they worsen credit rationing ex ante. This hinders firm creation and thus depresses labor demand. Rich agents who need few outside funds can invest even if creditor rights are weak. Hence, they favor soft laws that exclude poorer agents from the credit market and reduce the competition for labor. Such laws can generate greater utilitarian welfare than under perfect contract enforcement: By barring access to credit to some agents, soft laws lower wages, which increases the pledgeable income of richer agents and decreases the liquidation rates they must commit to. When they induce strong credit rationing, however, soft laws are Pareto-dominated by tougher laws combined with subsidies to entrepreneurs. (JEL: D82, G33, K22)

Creditor Protection and Bankruptcy Law Reform

Rafael La Porta and Florencio Lopez-de-Silanes

Resolution of Financial Distress, eds. Stijn Claessens, Simeon Djankov, and Ashoka Mody. Washington, D.C.:World Bank, 2001

No abstract

Debt Enforcement around the World*

Simeon Djankov, Oliver Hart, Caralee McLiesh and Andrei Shleifer

Insolvency practitioners from 88 countries describe how debt enforcement will proceed against an identical hotel about to default on its debt. We use the data on time, cost, and the likely disposition of the assets (preservation as a going concern vs. piecemeal sale) to construct a measure of the efficiency of debt enforcement in each country. This measure is strongly correlated with per capita income and legal origin and predicts debt market development. Several characteristics of debt enforcement procedures, such as the structure of appeals and availability of floating charge finance, influence efficiency.

Do Bankruptcy Codes Matter? A Study of Defaults in France, Germany and the UK

Sergei Davydenko and Julian Franks

Using a sample of small firms that defaulted on their bank debt in France, Germany, and the United Kingdom, we find that large differences in creditors' rights across countries lead banks to adjust their lending and reorganization practices to mitigate costly aspects of bankruptcy law. In particular, French banks respond to a creditor-unfriendly code by requiring more collateral than lenders elsewhere, and by relying on collateral forms that minimize the statutory dilution of their claims in bankruptcy. Despite such adjustments, bank recovery rates in default remain sharply different across the three countries, reflecting very different levels of creditor protection.

Entry Costs and Cross-Country Differences in Productivity and Output*

Levon Barseghyan

This paper contributes to the literature on cross-country income differences by studying the effect of entry barriers on productivity and output. Using instrumental variable regressions I show that higher entry costs significantly reduce output per worker and that they do so by lowering total factor productivity. In particular, an increase in entry costs by 80% of income per capita, which is one half of their standard deviation in my sample, is estimated to decrease total factor productivity and output per worker by 22% and 29%, respectively.

Entry Regulation as a Barrier to Entrepreneurship*

Leora Klapper, Luc Laeven and Raghuram Rajan

Using a comprehensive database of European firms, we study the effect of market entry regulations on the creation of new limited-liability firms, the average size of entrants, and the growth of incumbent firms. We find that costly regulations hamper the creation of new firms, especially in industries that should naturally have high entry. These regulations also force new entrants to be larger and cause incumbent firms in naturally high-entry industries to grow more slowly. Our results hold even when we correct for the availability of financing, the degree of protection of intellectual property, and labor regulations.

Legal Reform and Aggregate Small and Micro Business Bankruptcy Rates: Evidence from the 1997 Belgian Bankruptcy Code

Nico Dewaelheyns and Cynthia Van Hulle

Many Continental European countries recently reformed their bankruptcy legislations to stimulate reorganization and firm survival. We show that the Belgian 1997 bankruptcy code reform, which implemented several international best practice recommendations, significantly reduced aggregate small and micro business bankruptcy rates. However, using distributed lag models to control for the relationship between bankruptcy rates and macroeconomic variables such as real GDP growth, consumer confidence, inflation, etc., we find that the new code’s impact is not the same for all types of companies. Specifically, while the beneficial effect of the reform is largely similar between small firms (i.e., stock corporations) and micro firms (i.e., partnerships), it is only significant in certain industries (manufacturing and trade). Overall, our results indicate that especially the measures taken to limit domino bankruptcy effects are likely to have had a substantial impact. Our findings have several policy implications for the evaluation and modification of the bankruptcy system.

Personal Bankruptcy and Credit Supply and Demand

Reint Gropp, J. Karl Scholz and Michelle White

This paper examines how personal bankruptcy and bankruptcy exemptions affect the supply and demand for credit. While generous state-level bankruptcy exemptions are probably viewed by most policy-makers as benefiting less-well-off borrowers, our results using data from the 1983 Survey of Consumer Finances suggest that they increase the amount of credit held by high-asset households and reduce the availability and amount of credit to low-asset households, conditioning on observable characteristics. Thus, bankruptcy exemptions redistribute credit toward borrowers with high assets. Interest rates on automobile loans for low-asset households also appear to be higher in high exemption states.

Regulation and Growth*

Siemon Djankov, Caralee McLiesh and Rita Ramalho

Using objective measures of business regulations in 135 countries, we establish that countries with better regulations grow faster. Improving from the worst quartile of business regulations to the best implies a 2.3 percentage point increase in annual growth.

Survival Rates in Bankruptcy Systems: Overlooking the Evidence

Oscar Couwenberg

"Extensive research on bankruptcy still has not made it possible to end the efficiency discussion concerning the need for a reorganization provision in bankruptcy laws. In this paper, I discuss the pervasiveness of asset sales in bankruptcy procedures and the effect it has on survival rates. Without these figures on going concern asset sales Western countries show astonishingly low firm survival rates. In addition, it becomes clear that the bankruptcy system in the US may be under-researched to such an extent that it seriously confounds our view of bankruptcy resolution.