Proceedings of the German Development Economics Conference, Kiel 2005 / Verein für Socialpolitik, Research Committee Development Economics 18
The number of firm bankruptcies is surprisingly low in economies with poor institutions. We study a model of bank-firm relationship and show that the bank?s decision to liquidate bad firms has two opposing effects. First, the bank receives a payoff if a firm is liquidated. Second, it loses the rent from incumbent customers that is due to its informational advantage. We show that institutions must improve significantly in order to yield a stable equilibrium in which the optimal number of firms is liquidated. There is also a range where improving institutions may decrease the number of bad firms liquidated.
Credit markets institutions bank competition information sharing bankruptcy relationship banking