A General Equilibrium Analysis of Personal Bankruptcy Law

Abstract

We analyze an economy where principals (lenders, asset owners, franchisors) and agents (borrowers, tenants, franchisees) match and contract subject to moral hazard. Bankruptcy law defines the limited liability constraint in these contracts. We provide a Walrasian characterization of stable allocations and use it to analyze the distributional impact of changing bankruptcy law. We show (i) weakening liability law leads to a redistribution of debt from poor to rich agents; (ii) it makes rich agents better o and poor agents and principals worse o; (iii) exemption limits Pareto-dominate other bankruptcy laws if project size is fixed, and (iv) means testing (as used in the new US bankruptcy law) which is ex post pro-poor in intent makes the poor worse o ex ante.