Bankruptcy as a control device in economies in transition

We examine in this paper the design of a liquidation, or bankruptcy, policy in a partially centralized economy characterized by imperfect information. We employ a two-period model to analyze the effects of an optimal liquidation rule on the efficiency of resource allocation and choice of managerial effort when managers have private information about effort and firm productivity. First-period investment is used by the regulator to discipline the manager and to extract information. The tradeoff between disciplinary effect and information extraction might be best solved by implementing inefficient liquidation policies. Inefficiencies in liquidation policies can occur even if the regulator believes that he is facing a given type of firm with probability close to one.

Journal of Comparative Economics, 20(3), 265–301