When Should Bankruptcy Law Be Creditor- or Debtor-Friendly? Theory and Evidence
75 Pages Posted: 24 Sep 2016 Last revised: 26 Aug 2021
Date Written: April 1, 2018
We examine how creditor protection affects firms with different levels of owners' and managers' personal costs of bankruptcy. Theoretically, we show that firms with high personal costs of bankruptcy borrow and invest more under a more debtor-friendly management stay system, whereas firms with low personal costs of bankruptcy borrow and invest more under a more creditor-friendly receivership system. Intuitively, stronger creditor protection relaxes financial constraints but reduces credit demand. Which effect dominates depends on owners' and managers' personal costs of bankruptcy. Empirically, we find support for these predictions using a Korean bankruptcy reform, which replaced receivership with management stay.
Keywords: Bankruptcy, private benefits of control, investment, law and economics
JEL Classification: G31, G32, G33, G38, K22
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