Short-sighted bankruptcy law?

Bankruptcy was once seen as a major moral failure, revealing the reckless nature of the impecunious entrepreneur unable to face up to his obligations. Even nowadays, there are conflicting views about the ultimate goal of bankruptcy regimes: orderly liquidation of failed businesses or efficient re-organisation of viable concerns. In that respect, one often contrasts the "soft" US regime with the "tough" regime which until recently prevailed in most EU Member-States. In a recent TILEC discussion paper, TILEC member Emanuele Tarantino challenges the received wisdom according to which "soft" regimes have positive effects on the financing of long-term projects. Indeed, in the presence of moral hazard, the discontinuation of such projects is the optimal punishment for initially poor performance. If a lender can increase recovery rates in bankruptcy, then such punishment will no longer be credible, as the parties will always prefer renegotiating. Clearly, this exacerbates the difficulty for a lender ex ante to commit capital to long-term projects and may bias business activities towards short-term, less valuable investment projects.