When Should Bankruptcy Law Be Creditor- or Debtor-Friendly? Theory and Evidence

75 Pages Posted: 24 Sep 2016 Last revised: 26 Aug 2021

See all articles by David Schoenherr

David Schoenherr

Princeton University, Bendheim Center for Finance; European Corporate Governance Institute (ECGI)

Jan Starmans

Department of Finance, Stockholm School of Economics

Date Written: April 1, 2018

Abstract

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

Suggested Citation

Schoenherr, David and Starmans, Jan, When Should Bankruptcy Law Be Creditor- or Debtor-Friendly? Theory and Evidence (April 1, 2018). European Corporate Governance Institute (ECGI) - Finance Working Paper No. 512/2017, Journal of Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=2842803 or http://dx.doi.org/10.2139/ssrn.2842803

David Schoenherr (Contact Author)

Princeton University, Bendheim Center for Finance ( email )

26 Prospect Avenue
Princeton, NJ 08540
United States

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

Jan Starmans

Department of Finance, Stockholm School of Economics ( email )

Drottninggatan 98
Stockholm, 111 60
Sweden
+46 8 736 9181 (Phone)

HOME PAGE: http://sites.google.com/site/janstarmans11/

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