Debt Enforcement Around the World

In a recently published Journal of Political Economy paper entitled Debt Enforcement around the World (co-written with Simeon Djankov, Oliver Hart and Caralee McLiesh), my co-authors and I study debt enforcement with respect to an insolvent firm in 88 countries. To do so, we present insolvency practitioners in each country with the same case study of an insolvent firm. The case was developed jointly with the Committee on Bankruptcy of the International Bar Association to be representative of insolvency of a midsize firm in many countries. The firm is a hotel with a given number of employees, capital and ownership structure, value as a going concern, and a lower value if sold piecemeal. It is otherwise identical across countries except that the economic values are all normalized by the country’s per capita income.

Our analysis is organized around the procedures that the respondents say are likely to be used in their countries to address the insolvency of the hotel, which are (1) foreclosure by the senior creditor, which may or may not involve a court; (2) liquidation; and (3) reorganization. We find that debt enforcement around the world is highly inefficient, even in the relatively simple case we consider. The inefficiency comes from high administrative costs and long delays, but also from excessive piecemeal sales of viable businesses. The inefficiency is linked to underdevelopment, which probably proxies for poor public sector capacity of a country, and to French legal origin, which probably proxies for excessive formalism of the debt enforcement process. The inefficiency is also related to such structural aspects of debt enforcement as ineffective collateral systems, poorly structured appeals, business interruptions during bankruptcy, and inefficient voting among creditors. The inefficiency correlates with underdeveloped debt markets, consistent with the view that failures of debt enforcement discourage lending.

The narrative that emerges from these findings is straightforward. Developing countries follow the rich ones and introduce elaborate bankruptcy procedures, presumably designed to save and rehabilitate insolvent firms. In the rich countries, although these procedures are time consuming and expensive, they typically succeed in preserving the firm as a going concern. In the developing countries, in contrast, these procedures nearly always fail in their basic economic goal of saving the firm; in fact, 80 percent of insolvent businesses end up being sold piecemeal. The odds of saving the firm are especially low in the French legal origin countries, which have highly formal bankruptcy procedures. Our analysis suggests that less formalistic mechanisms might improve debt enforcement in a developing country. In addition, efficiency may be improved through a number of small changes in how debt enforcement is organized, such as restricting appeals in bankruptcy proceedings, moving toward absolute priority and to floating charge debt.

The full paper is available for download here. In addition, the data used in this paper can be downloaded from here.