Should Courts Enforce Credit Contracts Strictly ?
The linkages between law and finance are currently the centre of wideranging empirical investigations. This article analyse the effects of legal system efficiency on the functioning of the credit market by using a simple banking model with information asymmetries about borrowers'entrepreneurial talent. It is shown that improvements in the enforcement of contracts by courts reduce agency problems, but can also reduce banks' incentive to adequately screen borrowers, thus worsening credit allocation and social welfare. Improvements in accounting standards, however, always make bank screening of borrowers less costly and improve credit allocation.
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