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Revisiting Hungary's Bankruptcy Episode

  • John P. Bonin
  • Mark E. Schaffer

We take a retrospective look at Hungary's experiment with a particularly draconian bankruptcy law. For an eighteen-month period in 1992-93, the Hungarian bankruptcy code contained an unusual automatic trigger that required the managers of firms that held overdue debts of any size to any creditor to initiate reorganization or liquidation proceedings to avoid prosecution under the civil code. We analyze the impact of this "legislative shock therapy" on the economy during the period and examine its effects on resource reallocation and institution building. We argue that, although a key motivation for introducing the automatic trigger was to harden the budget constraints of firms, the empirical evidence suggests that hard budget constraints were already being imposed by banks and by other firms, and the effect of the automatic trigger was rather the exacerbation of a credit crunch and disruption of economic activity. We also suggest that other features of the Hungarian bankruptcy framework not connected to the automatic trigger provide the more important lessons. In particular, it is possible to introduce a bankruptcy track in a transition economy that can both transfer control of the firm from management to creditors and maintain the firm as a going concern while restructuring takes place.

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Paper provided by William Davidson Institute at the University of Michigan in its series William Davidson Institute Working Papers Series with number 255.

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Length: pages
Date of creation: 01 Sep 1999
Date of revision:
Handle: RePEc:wdi:papers:1999-255
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  1. Mitchell, Janet, 1998. "Strategic Creditor Passivity, Regulation and Bank Bailouts," CEPR Discussion Papers 1780, C.E.P.R. Discussion Papers.
  2. Jan Svejnar, 1991. "Microeconomic Issues in the Transition to a Market Economy," Journal of Economic Perspectives, American Economic Association, vol. 5(4), pages 123-138, Fall.
  3. Rajan, Raghuram G & Zingales, Luigi, 1995. " What Do We Know about Capital Structure? Some Evidence from International Data," Journal of Finance, American Finance Association, vol. 50(5), pages 1421-60, December.
  4. Janet Mitchell, 1998. "Bankruptcy Experience in Hungary and the Czech Republic," William Davidson Institute Working Papers Series 211, William Davidson Institute at the University of Michigan.
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