The Path to Economic Growth: Bankruptcy

[Joanne98]

posted by Elizabeth Warren
For years, lenders and the IMF have told developing countries that if they really want economic growth they need to adopt strong creditor-protection laws. Without that, no one will lend--or so they said. A new empirical paper takes another cut at that advice. According to a country-by-country analysis of merger and acquisition behavior, Creditors' Rights and Corporate Risk-Taking, strong bankruptcy laws may do more to promote beneficial risk-taking and economic growth.

The insight of the paper is interesting: strong creditor rights make corporations risk averse. As a result, these laws "induce costly risk avoidance," causing the companies to engage in practices that fail to maximize the value of the firm and it's potential. The study finds the effects are particularly strong in countries where management is ousted whenever the business fails.

The paper doesn't track failing companies. Instead, it focuses on corporate M&A decisions at the national level. It documents notes how asset-wasting, risk-averse decisions correlate with the strength of creditors' rights on a country-by-county basis. In other words, the failure to have strong bankruptcy laws to balance against the rights of individual creditors echoes through the whole economy, not just the behavior of distressed businesses.

The paper reminded me of a conversation that I used to have with my bankruptcy classes about why American bankruptcy law was so generous. In part, bankruptcy fit the the risk-taking attitudes of a young and growing nation populated by people who wanted to take a risk--and wanted to know that there would be a chance to take a second risk if the first one failed. As the US Congress limits the usefulness of bankruptcy as a reorganization tool--both in business cases and consumer cases--that conversation has become more historical.

http://www.creditslips.org/creditslips/2008/08/the-path-to-eco.html#more

[geckosfeet]

1. I am not an economist, but it appears to me that in the US bankruptcy

laws are quite lenient for corporations (Enron etc.) Hell. If they can convince the government that they are in financial trouble or that it is good for the economy the government will step in and bail them out with tax money.

On the other hand, bankruptcy laws for the individual taxpayer have been tightening like a noose.

[funflower]

2. Very interesting article. Elizabeth Warren always has a fresh take on things.

Thanks for posting.

[Indenturedebtor]

3. Great read thanks! Caught my eye because we're going through a BK ourselves

I actually have to NOT get another job so that we can do it heh. We would make just enough to not qualify otherwise so I have to let EVERYTHING go to shit before we can make it better. Under the new BK laws at my former income we were 3k a year over the limit lol. So now I have to go a couple of months without work, hoping we have enough to eat so we can start over. And we'll get behind on bills that we intend to keep paying.

It's pretty funny really.

Under and over is what the wife and I keep saying. Under and over.