Abstract
Exploiting a bankruptcy reform in Korea, I examine how shareholders' and managers' personal bankruptcy costs affect firms' financing and investment decisions. Under the pre-reform auction system incumbent management is forced to resign and the firm is sold to new investors. Under the post-reform management stay system, existing shareholders and incumbent management stay in control of the firm during bankruptcy proceedings. I find that firms curb risk-taking under the auction system, when bankruptcy states are costlier for managers and shareholders. Specifically, firms take on lower leverage, forego risky investment projects, and undertake less innovation under the auction regime. The effects are stronger for firms where private benefits of control are large and firms in which managers' wealth is more concentrated in the firm.
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