Quality of Institutions, Credit Markets and Bankruptcy

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.