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The Impact of Bankruptcy Rules on Risky Project Choice and Skill Formation under Credit Rationing

Author

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  • 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.

Suggested Citation

  • Gangopadhyay, Shubhashis & Wihlborg, Clas, 2001. "The Impact of Bankruptcy Rules on Risky Project Choice and Skill Formation under Credit Rationing," Working Papers 2001-5, Copenhagen Business School, Department of Finance.
    • Handle: RePEc:hhs:cbsfin:2001_005
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    File URL: http://openarchive.cbs.dk/cbsweb/handle/10398/7162
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    References listed on IDEAS

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    1. Cornelli, Francesca & Felli, Leonardo, 1997. "Ex-ante efficiency of bankruptcy procedures," European Economic Review, Elsevier, vol. 41(3-5), pages 475-485, April.
    2. Philippe Aghion & Patrick Bolton, 1992. "An Incomplete Contracts Approach to Financial Contracting," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 59(3), pages 473-494.
    3. Harris, Milton & Raviv, Artur, 1991. "The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
    4. Gertner, Robert & Scharfstein, David, 1991. "A Theory of Workouts and the Effects of Reorganization Law," Journal of Finance, American Finance Association, vol. 46(4), pages 1189-1222, September.
    5. Moore, Robert R, 1993. "Asymmetric Information, Repeated Lending, and Capital Structure," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 25(3), pages 393-409, August.
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    Cited by:

    1. Clas Wihlborg, 2002. "Insolvency and Debt Recovery Procedures in Economic Development: An Overview of African Law," WIDER Working Paper Series DP2002-27, World Institute for Development Economic Research (UNU-WIDER).

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    • A10 - General Economics and Teaching - - General Economics - - - General

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