Working Papers,
Copenhagen Business School, Department of Finance

Abstract: The contribution of this paper is in emphasizing endogenous credit rationing in the

analysis of effects of bankruptcy rules on entrepeneurs’ decisions with respect to risk-taking

and ex ante skill-development. Unlike most of the literature, both the debt claim

and the amount of debt financing is endogenous in our exercise. This allows us to

determine the extent of credit rationing that banks use to tackle informational asymmetry.

Credit rationing is non-trivial and increases the cost of capital when corporations are

forced to access alternative sources of funding even when debt is a cheaper alternative.

We thus solve for optimal debt-equity ratios in the capital structure of the corporation and

entrepeneurs’ risk-taking. Second, we allow entrepeneurs to invest in generating skill to

handle risky projects. We show that bankruptcy policies are important determinants of

all these outcomes in ways that in some cases contradict the existing literature, which

does not consider endogenous credit rationing.

Keywords: credit rationing; Bankruptcy rules; Financing

JEL-codes: A10

32 pages, August 1, 2001

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