Corrupt judges, credit rationing and the political economy of bankruptcy laws

University and the CEPR Conference on The Firm and its Stakeholders, for very insightful discussions and comments. The liquidation of distressed companies entails social costs, which lenders and managers do not fully inter-nalize. To mitigate this problem, bankruptcy laws in France and the US (in contrast with the UK or Germany) favor reorganization. The corresponding expropriation risk faced by creditors worsens credit rationing, espe-cially if bankruptcy judges are corrupt. Consequently tough bankruptcy laws, involving strict enforcement of debt contracts, can be socially optimal. Soft laws are likely to emerge, however, when the majority of citizens are so poor they would be credit rationed even under a tough bankruptcy law. In contrast, tough laws can be chosen when pivotal voters are middle class citizens who bene¯t from enhancing entrepreneurial opportunities. Corrupt judges, credit rationing and the political economy of bankruptcy laws