ABSTRACT
Financial development is hindered, if government defaults on its debt or
pursues inflationary, monetary policies. Such failure to live up to expectations shatters the previous expectational equilibrium and damages invest-
ment. Failing firms, however, do not need to create the same effect. Losses
of failing firms can be compensated by profits made by others without
undermining investor confidence. Limited liability restricts losses to oppor-
tunity costs. Failing firms usually retain some value, which restricts losses
below the opportunity costs of all claimants. Several groups of claimants
can be distinguished in bankruptcy procedures. Employees have claims on
wage payments; tax authorities on tax and social security payments; creditors want to retrieve their loans and shareholders want to recoup their
investments. Failing companies can either be liquidated or continue their
existence in reorganization. Reorganization should be preferred to liquida-
tion or acquisition, if more value is preserved in that way.
