Capture of Bankruptcy: Theory and Russian Evidence

Abstract

Laws that work well in developed market economies may produce unexpected outcomes in a corrupt environment. The paper argues that the Russian legal system is impaired by the capture of regional arbitration courts and analyzes the consequences of this capture for functioning of bankruptcy institution in the late 1990s. A model of strategic interaction among main stakeholders generates the following results. First, governors and managers of large regional enterprises colluded to use bankruptcy procedure as a mechanism of expropriation of the federal government’s revenues and claims of outside investors. Second, the bankruptcy law did not put pressure on managers to restructure; instead, the law could have prevented restructuring even when managers wanted to do so. Empirical analysis substantiates the theoretical findings and shows that regional political factors were important in explaining implementation of the 1998 Russia’s bankruptcy law.