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The Legal Enforcement of Credit Contracts and the Level of Investment

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Abstract

This paper analyses the effect of the degree of the legal enforcement of credit contracts on the level of private investment. We use a model of corporate finance with moral hazard and collateralized asset. We introduce in the model a third agent: the government, which is responsible for the enforcement of credit contracts. In particular we consider the right to repossess two different types of assets in case of default: inside collateral and outside collateral. We show that the existence of credit constraints and their level depend on the degree of enforceability of creditor rights, provided by the public sector. Moreover, we find the optimal degree of legal enforcement and we investigate how it depends on the firms' wealth endowment.

Suggested Citation

  • Daniela Fabbri, 2001. "The Legal Enforcement of Credit Contracts and the Level of Investment," CSEF Working Papers 57, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
  • Handle: RePEc:sef:csefwp:57
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    References listed on IDEAS

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    14. Alberto Bisin & Adriano Rampini, 2006. "Exclusive contracts and the institution of bankruptcy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(2), pages 277-304, January.
    15. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-689, October.
    16. Jeffrey Lacker, 2001. "Collateralized Debt as the Optimal Contract," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(4), pages 842-859, October.
    17. Erik BERGLÖF & Gérard ROLAND & Ernst-Ludwig VON THADDEN, 2000. "An Incomplete Contracts Approach to Corporate Bankruptcy," Cahiers de Recherches Economiques du Département d'économie 00.12, Université de Lausanne, Faculté des HEC, Département d’économie, revised Apr 2002.
    18. Bester, Helmut, 1985. "Screening vs. Rationing in Credit Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 75(4), pages 850-855, September.
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    Cited by:

    1. Felix Lopez-Iturriaga & Juan Antonio Rodriguez-Sanz, 2008. "Capital structure and institutional setting: a decompositional and international analysis," Applied Economics, Taylor & Francis Journals, vol. 40(14), pages 1851-1864.

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    More about this item

    Keywords

    moral hazard; collateral; corporate finance; legal enforcement;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • K1 - Law and Economics - - Basic Areas of Law
    • K4 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior

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