Working Paper: CEPR ID: DP3996
Authors: Bruno Biais; Thomas Mariotti
Abstract: We study the impact of different bankruptcy laws in general equilibrium, taking into account the interactions between the credit and labour markets, as well as wealth heterogeneity. Soft bankruptcy laws often preclude liquidation, to avoid ex-post inefficiencies. This worsens credit rationing, depresses investment and reduces aggregate leverage. Yet, tough laws do not necessarily maximize social welfare or emerge from the legislative process. Relatively rich agents can invest irrespective of the law. They favour soft laws that exclude poorer entrepreneurs from the market and thus reduce labour demand and wages. This raises the pledgeable income of the entrepreneurs who still can raise funds, and thus lowers their liquidation rates and the associated inefficiencies. Hence, a soft law can maximize social welfare.
Keywords: bankruptcy law; credit rationing; financial constraints
JEL Codes: D82; G33; K22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| soft bankruptcy laws (K35) | credit rationing (G21) |
| credit rationing (G21) | reduced investment (G31) |
| reduced investment (G31) | lower wages (J31) |
| soft bankruptcy laws (K35) | lower wages (J31) |
| tough bankruptcy laws (K35) | enhanced access to credit (G21) |
| enhanced access to credit (G21) | increased investment (E22) |
| increased investment (E22) | higher wages (J39) |
| tough bankruptcy laws (K35) | higher liquidation rates (G33) |
| higher liquidation rates (G33) | incentivized lenders to provide more credit (G21) |
| positive labor productivity shock (J49) | increased investment (E22) |
| increased investment (E22) | higher liquidation rates in financially constrained firms (G33) |