How Do Judges Judge? Evidence of Local Effect on French Bankruptcy Judgments

Abstract

Courts must audit and then screen out viable but failing firms after their filing for bankruptcy. Yet the judgment and its decision process remain a black box. The bankruptcy literature claims it is an optimal arbitrage between the going concern and the liquidation value. Deviations from the efficient judgment should be mainly explained because of the characteristics of the legal system through its tradition or its orientation. The main concern of the literature is to determine how these characteristics affect the efficiency of the decision. The aim of this paper is to challenge these models and to consider another factor, the local environment. The paper switches from the usual perspective and focuses on the Courts rather than on the legal system. It assumes this institution takes into account the local unemployment rate to decide whether a firm should survive or not. Possible explanations by the bankruptcy literature are tested – rational behavior, the firms are more viable when there is an increase of local unemployment rate; strict application of national orientation, the effect is drawn by national economic climate; over-interpretation of law, judges try to promote social efficiency in their decisions; or another explanation, a behavioral bias due to political beliefs or network issues. The analysis is based an original dataset of all Redressement Judiciaire – French main continuation proceeding – since 2006. Through several tests – using survival analysis in a competing risk setting, the paper finds that only the behavioral bias seems to hold. It assesses that Courts are locally embedded institutions that guard the firms under their jurisdiction against local turmoil.