Abstract
This paper analyzes how an enforcement mechanism that resembles a court affects firm finance. The court is described by two parameters that correspond to enforcement costs and the amount of creditor/debtor protection. We provide a theoretical and quantitative characterization of the effect of these enforcement parameters on the contract loan rate, the default probability and welfare. We analyze agents' incentive to default and pursue bankruptcy and show that when the constraints that govern these decisions bind, the enforcement parameters can have a sharply non-linear effect on finance. We also compute the welfare losses of "poor institutions" and show that they are non-trivial. The results provide guidance on when models which abstract from enforcement provide good approximations and when they do not.
Original language | English (US) |
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Pages (from-to) | 239-266 |
Number of pages | 28 |
Journal | Economic Theory |
Volume | 36 |
Issue number | 2 |
DOIs | |
State | Published - Aug 2008 |
Keywords
- Bankruptcy
- Contracts
- Creditor protection
- Debt
- Default
- Enforcement
- Inflation
- Legal environment
- Limited commitment
ASJC Scopus subject areas
- Economics and Econometrics