Judicial inefficiency delays bankruptcy, fosters zombie firms
A Banca d'Italia Occasional Paper finds that judicial inefficiency significantly reduces the likelihood and timing of bankruptcy filings. This contributes to the persistence of insolvent and 'zombie firms' with adverse implications for resource reallocation.
Inefficient courts deter filings
Using administrative data on Italian firms and courts, a Banca d'Italia paper finds that judicial inefficiency significantly reduces the likelihood and timing of bankruptcy filings.
To address endogeneity, the study instruments court efficiency with judge turnover.
Inefficient courts reduce the probability that financially distressed firms file for bankruptcy by about 8.7 percentage points, representing roughly 15% of the sample mean filing probability.
Furthermore, judicial inefficiency substantially delays bankruptcy filing, shortening pre-filing insolvency by about 11 months.
This also reduces by more than 10 percentage points the probability that a firm is continuously classified as a zombie in the three years preceding filing.
These delays contribute to the persistence of insolvent and zombie firms, with adverse implications for resource reallocation and aggregate productivity.
Distress resolution distorted
Bankruptcy institutions are crucial for resolving financial distress and reallocating resources in market economies.
Judicial efficiency significantly impacts their operation; lengthy and uncertain court proceedings increase insolvency costs, weaken creditor prospects, and distort firms' incentives.
Distressed firms may delay filing or avoid formal procedures, even when efficient resolution is needed.
The paper addresses these challenges using granular administrative data on Italian firms and courts from 2007 to 2021.
It focuses on Italy's two main in-court bankruptcy procedures: judicial compositions with creditors, akin to Chapter 11 in the US, and judicial liquidations, similar to Chapter 7.
A critical institutional friction
This research reveals judicial efficiency as a critical, often overlooked, institutional friction within insolvency systems.
It demonstrates that even robust legal frameworks are undermined by slow courts, perpetuating capital misallocation and the survival of unproductive 'zombie firms'.
For policymakers, improving judicial speed and certainty is as vital as the substantive insolvency laws themselves.