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Hainz, Christa (Juli 2004): Quality of Institutions, Credit Markets and Bankruptcy. Münchener Wirtschaftswissenschaftliche Beiträge (VWL) 2004-18


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 gets a payoff if a firm is liquidated. Second, it loses the rent from incumbent customers 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. However, in a particular range, improving institutions may even decrease the number of bad firms liquidated.