DP3996 Credit, Wages and Bankruptcy Laws

Author(s): Bruno Biais, Thomas Mariotti
Publication Date: August 2003
Keyword(s): bankruptcy law, credit rationing, financial constraints
JEL(s): D82, G33, K22
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3996

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.