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The Legal Enforcement of Credit Contracts and the Level of Investment

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    Abstract

    This paper analyses the effect of the degree of the legal enforcement of credit contracts on the level of private investment. We use a model of corporate finance with moral hazard and collateralized asset. We introduce in the model a third agent: the government, which is responsible for the enforcement of credit contracts. In particular we consider the right to repossess two different types of assets in case of default: inside collateral and outside collateral. We show that the existence of credit constraints and their level depend on the degree of enforceability of creditor rights, provided by the public sector. Moreover, we find the optimal degree of legal enforcement and we investigate how it depends on the firms' wealth endowment.

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    Bibliographic Info

    Paper provided by Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy in its series CSEF Working Papers with number 57.

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    Date of creation: 01 Apr 2001
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    Handle: RePEc:sef:csefwp:57

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    Keywords: moral hazard; collateral; corporate finance; legal enforcement;

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    1. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
    2. Erik BERGLÖF & Gérard ROLAND & Ernst-Ludwig VON THADDEN, 2000. "An Incomplete Contracts Approach to Corporate Bankruptcy," Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) 00.12, Université de Lausanne, Faculté des HEC, DEEP, revised Apr 2002.
    3. Jappelli, Tullio & Pagano, Marco & Bianco, Magda, 2005. "Courts and Banks: Effects of Judicial Enforcement on Credit Markets," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 37(2), pages 223-44, April.
    4. Jeffrey M. Lacker, 1998. "Collateralized debt as the optimal contract," Working Paper 98-04, Federal Reserve Bank of Richmond.
    5. La Porta, Rafael & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1997. " Legal Determinants of External Finance," Journal of Finance, American Finance Association, vol. 52(3), pages 1131-50, July.
    6. Rafael La Porta & Florencio Lopez-de-Silane & Andrei Shleifer & Robert W. Vishny, 1996. "Law and Finance," NBER Working Papers 5661, National Bureau of Economic Research, Inc.
    7. Reint Gropp & John Karl Scholz & Michelle White, 1996. "Personal Bankruptcy and Credit Supply and Demand," NBER Working Papers 5653, National Bureau of Economic Research, Inc.
    8. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-55, September.
    9. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-89, October.
    10. Chan, Yuk-Shee & Kanatas, George, 1985. "Asymmetric Valuations and the Role of Collateral in Loan Agreements," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 17(1), pages 84-95, February.
    11. Rafael LaPorta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert Vishny, . "Investor Protection and Corporate Governance," Working Paper 19455, Harvard University OpenScholar.
    12. Allen N. Berger & Gregory F. Udell, 1998. "The economics of small business finance: the roles of private equity and debt markets in the financial growth cycle," Finance and Economics Discussion Series 1998-15, Board of Governors of the Federal Reserve System (U.S.).
    13. Jeffrey Lacker, 2001. "Online Appendix to Collateralized Debt as the Optimal Contract," Technical Appendices lacker01, Review of Economic Dynamics.
    14. Krishna B. Kumar & Raghuram G. Rajan & Luigi Zingales, 1999. "What Determines Firm Size?," NBER Working Papers 7208, National Bureau of Economic Research, Inc.
    15. Holmstrom, Bengt & Tirole, Jean, 1997. "Financial Intermediation, Loanable Funds, and the Real Sector," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 663-91, August.
    16. Alberto Bisin & Adriano Rampini, 2006. "Exclusive contracts and the institution of bankruptcy," Economic Theory, Springer, vol. 27(2), pages 277-304, January.
    17. Andrew Powell & Marcela Cristini & Ramiro Moya, 2001. "The Importance of an Effective Legal System for Credit Markets: The Case of Argentina," Research Department Publications 3125, Inter-American Development Bank, Research Department.
    18. Bester, Helmut, 1987. "The role of collateral in credit markets with imperfect information," European Economic Review, Elsevier, vol. 31(4), pages 887-899, June.
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