Business Stealing And Bankruptcy

Mankiw and Whinston (1986) demonstrated that increased competition does not necessarily raise welfare when firms incur entry costs. Bankruptcy courts could have a role in discouraging overinvestment by their enforcement of financial contracts. The courts can move a homogenous goods industry closer to the social optimum by lowering the debt capacity and thereby increasing the taxable income of potential entrants. Further, it has been shown that exit is often insufficient in homogenous goods industries. This paper considers how bankruptcy courts can sometimes increase ex post social surplus by shutting down positive net present value firms.