IDEAS home Printed from
   My bibliography  Save this paper

Can bankruptcy law discriminate between heterogeneous firms when information is incomplete ? The case of legal sanctions


  • Régis Blazy

    () (Laboratoire de Recherche en Gestion et Economie, Institut d'Etudes Politiques, Strasbourg)


We study conditions under which legal sanctions may lead to an efficient selection of heterogeneous investment projects. The bankruptcy code is a "primitive creditor system" and financial distress leads to an arbitration between private agreement and costly formal bankruptcy. We consider a standard debt contract between a bank and a small firm, both risk-neutral. There are two types of leveraged firms in the economy: profitable firms and non-profitable ones. Before the debt repayment time, firms arbitrate between continuation and voluntary liquidation (considered strategies may be pure or mixed). Non-profitable firms may be incited to pursue business because of limited liability. The legislator computes a collectively optimal level of legal sanctions that incites good firms to continue and bad ones to liquidate. For any level of legal sanctions, we show that costly formal bankruptcies may occur at equilibrium and the internalization of bankruptcy costs is impossible. Besides, when bankruptcy costs are not too high, an infinite level of legal sanctions may allow such a selection among heterogeneous firms. Nevertheless, because legal sanctions are bound to the level of the assets shortage, the legislator's action only leads to a second best optimum.

Suggested Citation

  • Régis Blazy, 2004. "Can bankruptcy law discriminate between heterogeneous firms when information is incomplete ? The case of legal sanctions," Working Papers of LaRGE Research Center 2004-09, Laboratoire de Recherche en Gestion et Economie (LaRGE), Université de Strasbourg.
  • Handle: RePEc:lar:wpaper:2004-09

    Download full text from publisher

    File URL:
    Download Restriction: no

    More about this item


    Bankruptcy; debt; bargaining; legal sanctions; law & economics; efficiency; incomplete information.;

    JEL classification:

    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory


    Access and download statistics


    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:lar:wpaper:2004-09. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christophe J. Godlewski). General contact details of provider: .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.