How does legal design affect the initiation of a firm's bankruptcy?

Abstract

Changes in the bankruptcy legislation can have diverse consequences on firms. The current cross-country literature mainly relies on one legal dimension to capture such changes in the national bankruptcy law. Using a sample of 35 countries over the period from 2008 to 2018, we examine how multiple and simultaneous legal changes that occur in the design of the insolvency framework affect the initiation of a firm's bankruptcy. Our dynamic panel approach confirms that bankruptcy is initiated more often in countries where firms' assets are efficiently managed during the proceedings. By contributing to the preservation or enhancement of asset value, such a mechanism can provide incentives to managers, owners, and creditors of financially distressed firms to promptly initiate bankruptcy. Policy makers should be interested in supporting the efficient treatment of a firm's estate during bankruptcy as it can favor credit extension and asset allocation to more efficient owners or managers.