The Path to Economic Growth: Bankruptcy
For years, lenders and the IMF have told developing countries that if they really want economic growth they need to adopt strong creditor-protection laws. Without that, no one will lend--or so they said. A new empirical paper takes another cut at that advice. According to a country-by-country analysis of merger and acquisition behavior, Creditors' Rights and Corporate Risk-Taking, strong bankruptcy laws may do more to promote beneficial risk-taking and economic growth.
The insight of the paper is interesting: strong creditor rights make corporations risk averse. As a result, these laws "induce costly risk avoidance," causing the companies to engage in practices that fail to maximize the value of the firm and it's potential. The study finds the effects are particularly strong in countries where management is ousted whenever the business fails.
The paper doesn't track failing companies. Instead, it focuses on corporate M&A decisions at the national level. It documents notes how asset-wasting, risk-averse decisions correlate with the strength of creditors' rights on a country-by-county basis. In other words, the failure to have strong bankruptcy laws to balance against the rights of individual creditors echoes through the whole economy, not just the behavior of distressed businesses.
The paper reminded me of a conversation that I used to have with my bankruptcy classes about why American bankruptcy law was so generous. In part, bankruptcy fit the the risk-taking attitudes of a young and growing nation populated by people who wanted to take a risk--and wanted to know that there would be a chance to take a second risk if the first one failed. As the US Congress limits the usefulness of bankruptcy as a reorganization tool--both in business cases and consumer cases--that conversation has become more historical.
Efforts by Congress, by the IMF, and by big secured creditors who press for laws to give a handful of creditors the whip hand seem short-sighted to me. Whether a policymaker is sympathetic to debtors or creditors, a bankruptcy system that encourages beneficial risk-taking, that keeps corporations searching out new business opportunities, that encourages entrepreneurs to form small businesses, and that gives consumers a reason to go to work every morning is better for everyone--debtors, creditors and all the rest of us.