Working Paper: NBER ID: w23515
Authors: Dean Corbae; Pablo Derasmo
Abstract: In this paper, we ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. Using Compustat data, we first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, we then estimate parameters of a firm dynamics model with endogenous entry and exit to include both bankruptcy options in a general equilibrium environment. Finally, we evaluate a bankruptcy policy change recommended by the American Bankruptcy Institute that amounts to a “fresh start” for bankrupt firms. We find that changes to the law can have sizable consequences for borrowing costs and capital structure which via selection affects productivity (allocative efficiency rises by 2.58%) and welfare (rises by 0.54%).
Keywords: Bankruptcy; Firm Dynamics; Corporate Finance; Policy Reform
JEL Codes: E22; G32; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| bankruptcy law changes (K35) | borrowing costs (H74) |
| bankruptcy law changes (K35) | capital structure (G32) |
| bankruptcy law changes (K35) | allocative efficiency (D61) |
| bankruptcy law changes (K35) | welfare (I38) |
| bankruptcy law changes (K35) | bankruptcy rate (K35) |
| bankruptcy law changes (K35) | investment rate (E22) |
| bankruptcy law changes (K35) | productivity (O49) |
| bankruptcy law changes (K35) | total factor productivity (TFP) (D24) |
| bankruptcy law changes (K35) | aggregate consumption (E20) |
| bankruptcy law changes (K35) | bankruptcy costs (K35) |
| bankruptcy law changes (K35) | firm size distribution (L25) |
| bankruptcy law changes (K35) | incentives for firms to hold capital as collateral (D25) |