Optimal Asset Division Rules for Dissolving Partnerships

We study the optimal design of the bankruptcy code in dynamic production economies with limited commitment, where investment and the accumulation of (real) assets takes place. In particular, we will focus our attention on economies where the accumulation of assets is a collective rather than an individual decision. To find the optimal bankruptcy rule, specifying how to allocate existing assets among different partners, we need to balance risk sharing between the partners and output efficiency when new profitable opportunities may arise in the future. We consider both the case of private or public (verifiable) information on outside options. One of the key inside that under private information, defaulting agents will get a smaller proportion of accumulated assets, even though we will have typically more (and some socially inefficient) separations. We also study how the option of default affects ex ante asset accumulation under private and public information. This environment has several applications including business partnerships, couples and economic unions.