Abstract
We study how entrepreneurs’ attitudes toward risk, as measured by their personal legal infractions, are related to information asymmetry and agency problems prior to bankruptcy, using a sample of 260 small Swedish firms. We find that auditor resignations are more likely in firms where entrepreneurs have legal infractions. Furthermore, we find that legal infractions are negatively related to the likelihood of a firm disclosing its annual report and the quality of the bookkeeping, suggesting that information asymmetry problems are more severe when the entrepreneurs have legal infractions. We also find that creditors’ recovery rates in bankruptcy are lower if the entrepreneurs have legal infractions related to serious traffic offences, such as driving under the influence of alcohol or without a license.
Highlights
We examine how entrepreneurs’ prior legal infractions are related to information asymmetry and moral hazard problems prior to bankruptcy
We examine whether legal infractions are associated with decisions that magnify information asymmetry problems between the firm and creditors and whether they are associated with the magnitude of moral hazard problems prior to bankruptcy
Given that acts that are harmful to creditors and a delayed bankruptcy filing, reduce creditors’ recovery rates in bankruptcy, we propose the following hypothesis: H3
Summary
We examine how entrepreneurs’ prior legal infractions are related to information asymmetry and moral hazard problems prior to bankruptcy. Prior literature suggests that moral hazard problems in financially distressed firms arise when managers/owners take large dividends, invest in risky projects, or delay liquidation of economically unviable firms (e.g., Black and Scholes, 1973; Jensen and Meckling, 1976) Such actions may result in no or few assets left as the firm eventually files for bankruptcy. While the results correspond with the general view that information asymmetry and moral hazard problems influence bankruptcy (Dufrene, 1993; Mooradian, 1994; White, 1994; Dou et al, 2020), we are not aware of any prior study relating the entrepreneurs’ prior legal infractions to the severity of the problems in SMEs. The result can be important for lenders and suppliers.
Sign-in/Register to view highlights & summary Sign-in/Register to access full text options 
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
