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Bankruptcy and Entrepreneurship: The Value of a Fresh Start

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  • Kenneth Ayotte
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    Abstract

    This article considers bankruptcy law design in a setting that is appropriate for entrepreneurial firms. These firms are characterized by a dependence on an owner-manager who is essential to the firm and must be given incentive through an ownership stake to maximize the value of the project. In a relationship-lending environment, the banks that fund entrepreneurs cannot capture the gains from providing the entrepreneur with this stake, and this leaves the entrepreneur emerging from bankruptcy with a larger debt burden than is socially efficient. In this setting, a "fresh-start" bankruptcy policy provides greater debt relief than the bank would approve voluntarily, and this generates greater social surplus. The results suggest the value of separate procedures for small business bankruptcies that allow some mandatory debt relief to preserve ex post incentives. Copyright 2007, Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/jleo/ewm007
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    Bibliographic Info

    Article provided by Oxford University Press in its journal The Journal of Law, Economics, and Organization.

    Volume (Year): 23 (2007)
    Issue (Month): 1 (April)
    Pages: 161-185

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    Handle: RePEc:oup:jleorg:v:23:y:2007:i:1:p:161-185

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    Postal: Oxford University Press, Great Clarendon Street, Oxford OX2 6DP, UK
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    Cited by:
    1. Blazy, Régis & Deffains, Bruno & Umbhauer, Gisèle & Weill, Laurent, 2013. "Severe or gentle bankruptcy law: Which impact on investing and financing decisions?," Economic Modelling, Elsevier, vol. 34(C), pages 129-144.
    2. Bond, Philip & Newman, Andrew F., 2009. "Prohibitions on punishments in private contracts," Journal of Financial Intermediation, Elsevier, vol. 18(4), pages 526-540, October.
    3. Lee, Seung-Hyun & Yamakawa, Yasuhiro & Peng, Mike W. & Barney, Jay B., 2011. "How do bankruptcy laws affect entrepreneurship development around the world?," Journal of Business Venturing, Elsevier, vol. 26(5), pages 505-520, September.

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