Gangopadhyay, Shubhashis (Indian Statistical Institute,) Wihlborg, Clas (Department of Finance, Copenhagen Business School)
Abstract
The contribution of this paper is in emphasizing endogenous credit rationing in the
analysis of effects of bankruptcy rules on entrepeneurs’ decisions with respect to risk-taking
and ex ante skill-development. Unlike most of the literature, both the debt claim
and the amount of debt financing is endogenous in our exercise. This allows us to
determine the extent of credit rationing that banks use to tackle informational asymmetry.
Credit rationing is non-trivial and increases the cost of capital when corporations are
forced to access alternative sources of funding even when debt is a cheaper alternative.
We thus solve for optimal debt-equity ratios in the capital structure of the corporation and
entrepeneurs’ risk-taking. Second, we allow entrepeneurs to invest in generating skill to
handle risky projects. We show that bankruptcy policies are important determinants of
all these outcomes in ways that in some cases contradict the existing literature, which
does not consider endogenous credit rationing.
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Publisher Info
Paper provided by Copenhagen Business School, Department of Finance in its series Working Papers with number
2001-5.
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