The Low Usage of Bankruptcy Procedures: A Cultural Problem? Lessons from Spain

While filing for bankruptcy does not seem appealing for any debtor regardless of the jurisdiction, the reluctance to use the bankruptcy system varies across countries. This article explores the underlying reasons and economic effects of the low usage of bankruptcy procedures in Spain, where the rate of business bankruptcies is one of the lowest in the world. Some authors have argued that the low usage of bankruptcy procedures in Spain is due to a “cultural” problem faced by Spanish entrepreneurs. According to this hypothesis, the lack of a “bankruptcy culture” makes Spanish entrepreneurs afraid to use the bankruptcy system. In this article, however, I advocate for a totally different hypothesis. In my opinion, the low rate of business bankruptcies in Spain is not due to a “cultural” problem but to an institutional one. Namely, I argue that the low rate of business bankruptcies is better explained by the unattractive insolvency regime for debtors and creditors traditionally existing in Spain, as well as other legal and institutional factors including a creditor-friendly corporate law, an efficient mortgage system, a rigid labor law, and a poor law of secured transactions. All these factors encourage both debtors and creditors to avoid the use of insolvency proceedings either by minimizing the risk of insolvency or by postponing—and, if possible, even avoiding—the bankruptcy system once a debtor becomes insolvent. By exploring the underlying reasons for the low usage of the bankruptcy system in Spain, this article seeks to contribute to the general understanding of the low rate of business bankruptcies around the world while assessing the economic effects potentially associated with a low usage of insolvency proceedings. The article concludes with several recommendations to enhance the attractiveness of Spanish bankruptcy procedures

The Avoidance of Pre-Bankruptcy Transactions: An Economic and Comparative Approach

Most insolvency jurisdictions provide several mechanisms to reverse transactions entered into by a debtor prior to the commencement of the bankruptcy procedure. These mechanisms, generally known as claw-back actions or avoidance provisions, may fulfil several economic goals. First, they act as an ex post alignment of incentives between factually insolvent debtors and their creditors, since the latter become the residual claimants of an insolvent firm, but they do not have any control over the debtor’s assets while the company is not yet subject to a bankruptcy procedure. Thus, avoidance powers may prevent or, at least, reverse opportunistic behaviors faced by factually insolvent debtors prior to the commencement of the bankruptcy procedure. Second, these devices may also prevent the creditors’ race to collect when insolvency threatens. Therefore, the existence of avoidance actions may reduce, at an early stage, the “common pool” problem that bankruptcy law seeks to solve. Third, avoidance powers also protect the interests of both the debtor and its creditors when the former is facing financial trouble and some market participants want to take advantages of this situation. Finally, the avoidance of pre-bankruptcy transactions can also be helpful for the early detection of financially distressed debtors, so it may encourage managers to take corrective actions in a timely manner. As a result of these goals, the existence of avoidance powers can create several benefits. However, the use—and even existence—of avoidance actions is not costless. On the one hand, the use of these actions may generate litigation costs. On the other hand, the existence of these mechanisms may harm legal certainty, especially in countries in which it is relatively easy to avoid a transaction, usually because bad faith is not required, the look-back period may be too long, or no financial conditions are required to avoid a transaction. Therefore, insolvency legislators should carefully deal with these costs and benefits in order to make sure that the existence of avoidance powers does not do more harm than good. On the basis of this exercise, this paper analyzes, from a comparative and functional approach, the optimal way to design claw-back actions across jurisdictions

Addressing the Auditor Independence Puzzle: Regulatory Models and Proposal for Reform

Auditors play a major role in corporate governance and capital markets. Ex ante, auditors facilitate firms’ access to finance by fostering trust among public investors. Ex post, auditors can prevent misbehavior and prevent financial fraud by corporate insiders. In order to fulfill these goals, however, in addition to having the adequate knowledge and expertise, auditors must perform their functions in an independent manner. Unfortunately, auditors are often subject to conflicts of interest, for example, resulting from the provision of nonaudit services but also because of the mere fact of being hired and paid by the audited company. Therefore, even if auditors act independently, investors may have reason to think otherwise. Policymakers and scholars around the world have attempted to solve the auditor independence puzzle through a variety of mechanisms, including prohibitions and rotation requirements. More recent proposals have also included breaking up audit firms and the empowerment of shareholders. This Article argues that none of these solutions is entirely convincing. Drawing from corporate governance, law and economics, and accounting literature, this Article proposes a new model to solve the auditor independence puzzle. Our proposal rests on four pillars. First, this Article argues that, in the context of controlled firms, auditors should be elected with a majority-of-the-minority vote. Second, while auditors in many jurisdictions are subject to certain temporal prohibitions to be hired by previous clients, the Article proposes that the length of these temporal prohibitions should be extended. Moreover, regulators should also restrict the type of services potentially provided to the audit client. Third, policymakers must pay closer attention to the internal governance and compensation systems of audit firms. The Article argues that increased transparency of audit firms is essential to enhance the independence of auditors. Finally, studies have shown that audit committees often fail to perform their monitoring functions, a major reason being the influence of corporate insiders on the committee. For this reason, we propose to increase the power and presence of public investors in the audit committee

The avoidance of pre-bankruptcy transactions: An economic and comparative approach

Most insolvency jurisdictions provide several mechanisms to reverse transactions entered into by a debtor prior to the commencement of the bankruptcy procedure. These mechanisms, generally known as claw-back actions or avoidance provisions, may fulfil several economic goals. First, they act as an ex post alignment of incentives between factually insolvent debtors and their creditors, since the latter become the residual claimants of an insolvent firm, but they do not have any control over the debtor’s assets while the company is not yet subject to a bankruptcy procedure. Thus, avoidance powers may prevent or, at least, reverse opportunistic behaviors faced by factually insolvent debtors prior to the commencement of the bankruptcy procedure. Second, these devices may also prevent the creditors’ race to collect when insolvency threatens. Therefore, the existence of avoidance actions may reduce, at an early stage, the “common pool” problem that bankruptcy law seeks to solve. Third, avoidance powers also protect the interests of both the debtor and its creditors when the former is facing financial trouble and some market participants want to take advantages of this situation. Finally, the avoidance of pre-bankruptcy transactions can also be helpful for the early detection of financially distressed debtors, so it may encourage managers to take corrective actions in a timely manner. As a result of these goals, the existence of avoidance powers can create several benefits. However, the use—and even existence—of avoidance actions is not costless. On the one hand, the use of these actions may generate litigation costs. On the other hand, the existence of these mechanisms may harm legal certainty, especially in countries in which it is relatively easy to avoid a transaction, usually because bad faith is not required, the look-back period may be too long, or no financial conditions are required to avoid a transaction. Therefore, insolvency legislators should carefully deal with these costs and benefits in order to make sure that the existence of avoidance powers does not do more harm than good. On the basis of this exercise, this paper analyzes, from a comparative and functional approach, the optimal way to design claw-back actions across jurisdictions