Agency Costs, Creditor Rights and Economic Growth

The degree of creditor protection and the cost of resolving bankruptcy are two central issues in the ongoing debate about bankruptcy law reforms in several countries. In order to analyze whether creditor protection and liquidation costs affect lending decisions and eco-nomic growth, I incorporate what I call bankruptcy technology in a standard overlapping-generations model of capital accumulation. The bankruptcy technology is parsimoniously summarized by two parameters describing the cost of bankruptcy and the creditor pro-tection. I find that a simultaneous reduction in bankruptcy costs and an improvement in creditor protection have a significant impact on growth. This impact is larger than the effect of only reducing bankruptcy costs, or of only increasing creditor protection. The paper’s main normative lesson is that countries reforming their bankruptcy laws should not only relax the constraints to a rapid resolution of insolvency but also improve creditor rights