Insolvency institutions and efficiency: the Spanish case

Miguel Garcia-Posada

No 1302, Working Papers from Banco de España

Abstract: The paper warns about the potential efficiency losses associated with low business bankruptcy rates (number of firms filing for bankruptcy as a proportion of the total stock of firms) and shows that welfare could be improved by increasing the protection of creditors in the bankruptcy system. These ideas are illustrated with the Spanish case. The paper also predicts a positive correlation between welfare and bankruptcy rates, a finding that seems consistent with the empirical evidence. The argument, analysed with an incomplete contracts model à la Bolton and Scharfstein (1996), is as follows. The low efficiency and low creditor protection of the Spanish bankruptcy system relative to those of an alternative insolvency institution, namely the mortgage system, mean that firms and their creditors mainly deal with credit provision and eventual insolvency through the latter. However, in order to use the mortgage system, some firms must overinvest in capital assets (real estate, equipment) since those are the assets that can be pledged as mortgage collateral. This overinvestment leads to productive inefficiencies, which may be very costly for industries that require a high level of other factors of production (e.g. R&D). Furthermore, the mortgage system is too creditor friendly, in the sense that it always grants the control of the firm’s assets to creditors in the event of default. Since creditors are inherently biased towards liquidation, this leads to some inefficient liquidations

Keywords: bankruptcy; mortgage; insolvency; efficiency (search for similar items in EconPapers)
JEL-codes: D6 G21 G33 K0 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2013-02
References: View complete reference list from CitEc
Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:bde:wpaper:1302

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