In recent years the U.S. experienced an increase in the share of default events that are resolved out-of-court, as well as a reduction in bankruptcy-related costs. This trend raises the question as to what drives the frequency with which defaults turn into bankruptcies. We propose a theory based...

We show that when borrowers are privately informed about their creditworthiness and lenders have a soft budget constraint, efficient investment requires a limit on the fraction of a firm’s cash flows that can be pledged to outsiders. That is, pledgeability should neither be too low nor too...