SOFT BANKRUPTCY LAW, FINANCIAL CONSTRAINTS, AND THE STRUCTURE OF CORPORATE OWNERSHIP

This paper studies the ownership structure of firms in a framework with asymmetric information (two types of moral hazard) and strong debtor protection (a soft bankruptcy procedure like the Chapter 11 in the US). Debtor-oriented bankruptcy law is characterized by an interesting trade-off it worsens the managerial moral hazard effort problem but at the same time it induces the revelation of firms' difficulties earlier than a creditor-oriented (tough) procedure. Depending on which of the two effects dominates, firms will obtain financing from either a large block-holder or several dispersed shareholders. A company's ownership structure is determined by the extent to which entrepreneurs are financially constrained. When the effort moral hazard problem prevails, a block-holder who engages in costly monitoring is optimal to circumvent credit rationing. If the problem concerning the decision to file for bankruptcy is stronger, then dispersed ownership can do better. Our main argument is that that some of the bad effects introduced by a debtor-oriented bankruptcy procedure can be (at least partially) removed by capital adjustments which, in turn, determine a corporate ownership structure. This paper is also an advocate of the "law matters" thesis and shows the influence of institutional arrangements on a firm's ownership structure. We also provide new insights on the often criticized soft bankruptcy procedures.