Job Market Paper

"Macroeconomic implications of insolvency regimes"

Abstract

This paper investigates the importance of creditor and debtor rights in insolvency on firm production and aggregate labour productivity. I build a heterogeneous firm model with financial frictions where defaulting firms can enter insolvency and continue production or be liquidated and exit. Financial frictions impact firm production decisions and makes capital relatively more costly than labour for borrowing constrained firms. As a result, financially constrained firms are less capital intensive and have a lower capital-to-labour ratio than unconstrained firms. Two insolvency regimes are compared, a creditor-friendly regime such as the UK and a debtor-friendly regime such as the US. Debtor-friendly regimes are shown to be more costly in the steady-state, leading to larger spreads on firm debt. The model dynamics find a response to productivity shocks that are largely consistent with the UK and the US following the financial crisis. The model predicts that labour productivity falls more sharply in the creditor-friendly regime while employment does not. This paper suggests a possible explanation for the different employment and labour productivity response in the UK and US since the Financial Crisis.