The Low Use of Bankruptcy Procedures in Spain: Reasons and Implications for the Spanish Economy

Abstract

This paper seeks to contribute to the understanding of the relative use of bankruptcy law. Namely, it explores the underlying reasons for the low rate of business bankruptcies in Spain, and the impact that this low usage of bankruptcy procedures may have for Spanish firms – and thereby for the Spanish economy. There are two main hypotheses that may explain the low level of business bankruptcies: (i) Spanish firms minimize ex ante the risk of bankruptcy; or (ii) Spanish firms resolve their financial trouble without using formal bankruptcy procedures. This paper proposes an intermediate hypothesis. Namely, it argues that, induced by both the legislator and secured creditors, Spanish firms choose asset and capital structures that minimize ex ante the risk of bankruptcy. Moreover, when insolvency already threatens, firms seem to avoid the use of bankruptcy procedures due to the unattractiveness of the Spanish bankruptcy system for both debtors and creditors. Likewise, this paper points out that the low rate of business bankruptcies might not be mainly associated, as previous studies have suggested, with the unattractiveness of the bankruptcy system and the efficiency of the mortgage system, but also – and perhaps more importantly – with other factors such as the design of a creditor-friendly corporate law, a poor the law of secured transactions, the use of workouts, and some economic and sociological factors usually generated or, at least, exacerbated by the legislator. These latter factors include: (i) the stigma associated with Spanish bankruptcy procedures; (ii) the high level of risk aversion faced by Spanish entrepreneurs (especially small and medium size entrepreneurs); (iii) the bad perception of the Spanish bankruptcy system; and (iv) the low recognition of business success linked to the bad connotations of business failure in Spain. Finally, it is argued that the high dependence of Spanish firms to bank finance and the poor culture of bank lending (mainly dependent on the debtor's ability to provide a security interest instead of focusing on the debtor´s ability to generate cash flows) contributes to the inefficient design of the asset and capital structure of Spanish firms. Moreover, it can create several externalities to society as the result of the overinvestment and underinvestment problems potentially created by this culture of bank lending. On the basis of this exercise, this paper contributes to the literature by introducing new variables that may help explain the relative of bankruptcy law. Likewise, it proposes a structural reform of the Spanish Bankruptcy Act 2003 to make bankruptcy procedures more attractive to both debtors and creditors, and it suggests several recommendations to promote the optimal design of the asset and capital structures of Spanish firms with the purpose of boosting the competitiveness and growth of the Spanish economy.