An experimental investigation on optimal bankruptcy laws

Most of the existing bankruptcy laws distort managerial incentives. The aim of this paper is to test whether the ”restricted auction” mechanism proposed by Berkovitch, Israel and Zender (1997) is an optimal bankruptcy law, that is a commitment device that implements both ex ante and ex post efficiency in firm-specific investment decisions when moral hazard is binding. In order to do that, we ran a computerized experiment on a sample of 150 undergraduate students at LUISS Guido Carli University of Rome. We concluded that on average the restricted auction mechanism was able to direct more effort toward entrepreneurial activities than any unrestricted auction mechanism.