Abstract
An efficient bankruptcy system should liquidate nonviable businesses and reorganize viable ones. The importance of this filtering process has long been recognized in the literature; the typical reason advanced for its failure has been biases (in codes or among judges). In this paper we show that bankruptcy costs can be another source of such filtering failure. We illustrate this with the Colombian reform of 1999. Using data from 1,924 firms filing for bankruptcy between 1996 and 2003, we find that the prereform reorganization proceedings were so inefficient that the bankruptcy system failed to separate economically viable firms from inefficient ones. In contrast, by streamlining the reorganization process, the reform contributed to the improvement of the selection of viable firms into reorganization. In this sense, the new law increased the efficiency of the bankruptcy system in Colombia.
Highlights
Ninety countries around the world have reformed their bankruptcy codes since World War II and over half of them have done so during the last decade
We conclude that the new law increased the efficiency of the bankruptcy system in Colombia
This paper studies the relevance of reorganization costs for the efficiency of bankruptcy laws
Summary
Ninety countries around the world have reformed their bankruptcy codes since World War II and over half of them have done so during the last decade. In other words, depending on the distribution of expected reorganization costs across firms, the distribution of cash-flows between firms that restructure and those that liquidate before the law could be the same. Because the law is introduced during a major crisis, one could make the argument following Shleifer and Vishny (1992) that adverse macroeconomic conditions may lower liquidation values (as well as the distribution of cash-flows) This is important in the context of the model because the result of separation of viable and unviable firms obtained from a relative improvement of reorganization costs could come from lower liquidation values.. Of these cases, 21 failed and moved to mandatory liquidation.
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