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3. Systems characterized by a comparatively low level of develop ment of financial markets (Under Developed Systems). The main bulk of the financing relied upon by commercial and industrial companies is provided by banks. However, the informational content of the process being formed in different sectors of the nascent financial markets turns out to be scarcer; also, the companies reporting is less transparent, and there are no reliable ratings. All this must induce comparatively lower values of structural characteristics (1r). On the other hand, the CEOs of non financial companies have clear notions as to the creditors possible sources of information; also, these CEOs often have secure (personal) connections with banks. Consequently, here the preva lence of hard information structures may also be assumed.

By plotting values (1r) on X axis, and specific weight of hard infor mation, h, on Y axis, the author can characterize the relations develop ing between different systems in the following way42 (see fig. 1):

Allen F., D. Gale A Welfare Comparison of the German and U.S. Systems. European Economic Review, 1995. Vol. 39, pp. 179209. . Allen F., D. Gale Comparing Financial Systems MIT Press: Cambridge, 2000.

Berkovich E., R. Israel Optimal Bankruptcy Laws Across Different Economic Systems. The Review of Financial Studies, 1999, Vol. 12, p.p. 368.

h B A 1 1r Fig. 1. Information structures in different economic systems Area A, according to the authors, must characterize economic sys tems based on the capital markets functioning; area B economic sys tems where the central role is played by banks; area C systems where a comparatively lower level of financial markets development can be observed.

In actual practice, bankruptcys characteristics, naturally, cannot be reduced just to an unlucky choice of a plan and the possibility (or im possibility) to conceal from the Creditor, for a certain period of time, the information concerning the plans quality. In real life, both the sources of a companys insolvency and the relations developing between the interested parties, as noted earlier, are far more variable and complex.

Nevertheless, in the model under consideration the authors have suc ceeded in stating certain peculiar features of the relationship between the Manager and the Creditor. Besides, the model is of a rather general character: bankruptcy is only one of the outcomes that can potentially be realized in the course of the discussed interaction between the said actors. So, let us make up a short list of the numerous conclusions that can be drawn on the basis of this model.

Two mechanisms of bankruptcy can be singled out: 1) the one cor responding to the creditors strategy, and 2) the one corresponding to the debtors strategy. For a system where the central role is played by banks, the optimal procedures envisage only the mechanism corre sponding to the creditors strategy. This mechanism is determined as follows. After the Creditor has initiated the proceedings in bankruptcy, the Manager is allowed to submit his proposals concerning the future destiny of the bankrupt company. If the Creditor rejects these propos als, the court makes the decision that the company be liquidated, and utilizes the incomes from the market sale of the bankrupts assets for repaying its debts. If the project submitted by the Manager has satisfied the Creditor, it becomes the basis for a new credit contract.

For economic systems based on the capital markets functioning, the optimal bankruptcy procedures envisage that the court resorts to the mechanisms which correspond to the creditors strategy. More complex (randomized) procedures are envisaged for the instance when a companys bankruptcy is declared by the Manager. With probability (1r), the court resorts to the same mechanism, corresponding to the creditors strategy, and with probability r applies the mechanism corre sponding to the debtors strategy. In the latter case, the roles become reversed: the mechanism corresponding to the debtors interests im plies that in accordance with the courts decision the Creditor submits for the Managers consideration the project for settling the problems that have arisen. If such a project is to the Managers satisfaction, the claims of the owners of debt obligations are considered to have been satisfied, and the suggested project lays the foundation for a new credit contract. If the Manager rejects the Creditors proposal, the former credit contract remains in force43.

For underdeveloped systems, the optimal bankruptcy procedure does not require any randomization it simply implies separate applica tion of the procedures described: in those instances when the proceed ings in bankruptcy are initiated by the Creditor, the court must trigger a mechanism compatible with the creditors strategy, whereas when the initiator is the Manager, the mechanism must be compatible with the debtors strategy. It is assumed that the personnel, which in this system has monopoly over the access to information, can realize this strategic advantage and resort to the bankruptcy mechanism which best corre sponds to the debtors interests.

Note a curious consideration that can be found in these recommendations. In the latter of the cases under study (bankruptcy is declared by the Manager; a mechanism corre sponding to the debtors strategy is put into action, whereas the Manager refuses to ac cept the creditors proposal; in this event, the creditors may have an interest in the con tinued functioning of a non profitable company). The Creditor is obliged to pay a certain fine. In accordance with this models logic, this must undermine the interest of the credi tors in the continuation of the inefficient functioning of the borrower company.

The analysis of situations in the systems with nascent financial mar kets seems to be somewhat superficial anyway, not touching upon the essence of the most serious problems faced by the economy in transi tion. Under the conditions when property rights are not consistently and clearly enough determined by legislation, and the judicial system is cor rupt and inefficient (including the system of bankruptcy commission ers), bankruptcy procedures inevitably become the embodiment of abuse and an instrument applied in the struggle for redistribution of property and shareholder control. In more detail these issues will be dealt with in the next sections; here we are simply going to note the role of some of the requirements imposed by the optimal bankruptcy proce dures.

In the described bankruptcy practice, when it is applied in a devel oped market economy, and especially in projects designed to further reform this practice, the range of powers and the ability to make inde pendent decisions are reduced to a minimum. The act of bankruptcy as such represents, in fact, a signal informing that the State is not going to predetermine the outcome of the emerging conflict in any way and will not support an insolvent company by the government funds, or enforce its closure. The arising losses must be borne by (and somehow distrib uted between) private parties the companys owners and creditors.

The procedure for settling this conflict implies, first of all, that the debtor and creditors must have every possibility for achieving a mutual agreement. In such instances, any subsequent application of bank ruptcy procedures becomes superfluous.

If, however, there is no possibility to avoid court proceedings, the solution to the problem associated with a possible property and control redistribution is sought along the lines of finding a mutually beneficial equilibrium of interests, and through applying various mechanisms of checks and balances. By way of illustration, it will suffice to refer to the abovesaid considerations determining the optimal bankruptcy proce dures (those compatible with the interests of both the creditors and the debtor). Each of the conflicting parties is granted certain opportuni ties for withdrawal, which are not the same in different economic sys tems: thus, one of the parties offers its own plan for the conflicts set tlement, and this plan cannot be accepted without the other partys ap proval. Such an approach imposes serious barriers against a possible violation of property rights and against bankruptcy being applied as an instrument for arbitrary redistribution of property and shareholder con trol.

However, the procedure cannot be limited to bilateral bargaining.

Wherever possible, economically reasonable bankruptcy procedures appeal to competition mechanisms. Efficient solutions in this context most often are associated with widening the range of information being collected and processed, as well as with the choice of the best plan, based on multi step market auctioning.

The potential distribution of options with different premiums be tween the interested parties is also aimed at reducing the rigidity of these procedures. Owing to such schemes, the degree of participation of each of the parties in settling the issue of whether to reorganize or liquidate a bankrupt company directly depends on their decision to use (or not to use) the options granted, and this, in the final analysis, is regulated by the situation developing on the market and the expecta tions of the parties involved.

The courts of justice (and genuinely independent experts) are as signed the roles of primarily an organizer and coordinator of these pro cedures. The optimal bankruptcy rules and the reforms proposed in this sphere most often rely on the application of efficient self regulation mechanisms, where the process outcome is determined by the results of bidding and by market forces, and is not reduced to arbitrary deci sions of the judicial and legal agencies (or the executive authority, when it intrudes in this sphere). The bankruptcy rules as such, as well as the competition procedures to which these rules are applied, limit the sphere of activity and the powers of the judicial agencies.

The expansion of these powers seems especially dangerous in situa tions when the arbitrage courts actually depend on the regional or fed eral administration. Thereby the opportunities for interested parties to influence the process outcome through direct bribing or the proposals to trade services are also expanded44.

Thus, in a case when proceedings in bankruptcy are initiated with the goal of property redistribution, delegating extensive powers to the bankruptcy commissioner at the initial stages (while the grounds for initiating such proceedings are being investigated) may result, as shown by experience, in a situation when CEOs, with their own gains in mind, increase the defendants insolvency.

In a number of instances, an important role can be played by factors associated with political engagements (thus, representatives of judicial agencies, especially the older generation judges, are quite often op posed to transfers of large enterprises into the hands of foreign owners, oligarchs, etc.)45. Instead of being an instrument for economic recov ery, bankruptcies become simply a tool for achieving transient political goals.

Bankruptcy regulation existing in some countries with nascent finan cial markets impose strong limitations on the real opportunities that can be opened not only by auction bidding, but also by bilateral compro mise settlements between the participants (earlier, much attention has been given to the important place they occupy, e.g., in the US bank ruptcy practices). It is symbolic that negotiations between creditors and the CEOs of a bankrupt company do not play any serious role not only in many transition economies, but also in the countries of South East Asia46. It is these procedures, vastly limiting the performance of compe tition mechanisms, that open the ways for external pressure, corrup tion and inefficient administration.

An optimal functioning of property rights must imply, in particular, an efficient protection of a bankrupt companys property from misappro priation. It has already been noted (see Section 1) that even in a devel oped economy there may appear incentives for the CEOs of a company on the verge of bankruptcy to withdraw the largest possible part of its assets. Therefore, one more function of the judicial authorities would be to actively and carefully protect this companys property from covert plundering. This task becomes even more important in countries with economies in transition where, due to the imperfection of legislation designed to regulate property rights and to inefficient control mecha The opportunities for arbitrary administrative decisions become even greater when fac tors like a companys (or enterprises) social significance are made relevant in the course of these procedures. By compiling special social significance lists, the imple mentation of the strategy pursued not by the third, but already by the second (executive) authority, as well as the partied hiding behind it, can be made easier.

See, e.g., Claessens S., S. Djankov, D. Klingebiel Financial Restructuring in East Asia:

Halfway There in: Resolution of Financial Distress: An International Perspective on the Design of Bankruptcy Laws ed. by S. Claessens, S. Djankov, A. Mody. World Bank:

Washington, 2000.

Claessens, Djankov, Klingebiel, 2001.

nisms, asset withdrawal begins long before the initiation of bankruptcy procedures.

This factor is also responsible for the widespread practice of pre meditated bankruptcies, when the CEOs (often performing, in fact, the functions of a companys owners), having withdrawn much of its assets, resort to bankruptcy procedures in order to get rid of their arrears of payments due to the State and private partners. In such situations, the judicial authorities, naturally, are unable to recover (in full) the money due against these liabilities, the economic structures having become emptied from inside47.

The problem associated with asset withdrawal from companies prior to premeditated bankruptcies is, certainly, far broader than the issues discussed here, and requires a special study. Still, we should like to note three points that have a direct bearing on bankruptcy procedures.

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