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Economics of bankruptcy exemption: Signaling value of collateral, cost of credit and access to credit

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  • P. Arca
  • G. Atzeni

    ()

  • L. Deidda

    ()

Abstract

We analyze the effect of a bankruptcy law according to which some of the borrower’s assets are exempt from liquidation in the event of default in the context of a competitive credit market characterized either by moral hazard (MH) or by adverse selection (AS). In particular, we study how the level of such exemption affects the role of collateral depending on the dominant source of asymmetric information. Under MH, conditional on the level of exemption, the cost of credit is higher for borrowers who are requested to post collateral. Moreover, conditional on posting collateral, the cost of credit does not change with the level of asset exemption. Differently, in the case of AS, the decision to post collateral results in a lower cost of credit, whenever the equilibrium is separating. Finally, under AS, a higher level of exemption is generally associated with a lower level of credit rationing. Similarly, credit rationing either stays unchanged or goes down with exemption in the case of MH. We exploit cross State variability in the level of asset exemption from liquidation – according to personal bankruptcy US State laws prior to 2005 federal reform – in order to identify the signaling role played by collateral in a sample of american small business taken from the SBFF data.

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Bibliographic Info

Paper provided by Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia in its series Working Paper CRENoS with number 201302.

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Date of creation: 2013
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Handle: RePEc:cns:cnscwp:201302

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Keywords: signal; screening; moral hazard; exemption levels; collateral; bankruptcy;

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  1. Berger, Allen N. & Cerqueiro, Geraldo & Penas, María F., 2011. "Does debtor protection really protect debtors? Evidence from the small business credit market," Journal of Banking & Finance, Elsevier, Elsevier, vol. 35(7), pages 1843-1857, July.
  2. Gropp, Reint & Scholz, John Karl & White, Michelle J, 1997. "Personal Bankruptcy and Credit Supply and Demand," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 112(1), pages 217-51, February.
  3. Lin, Emily Y. & White, Michelle J., 2001. "Bankruptcy and the Market for Mortgage and Home Improvement Loans," Journal of Urban Economics, Elsevier, vol. 50(1), pages 138-162, July.
  4. Fan, Wei & White, Michelle J, 2003. "Personal Bankruptcy and the Level of Entrepreneurial Activity," Journal of Law and Economics, University of Chicago Press, University of Chicago Press, vol. 46(2), pages 543-67, October.
  5. Besanko, David & Thakor, Anjan V, 1987. "Collateral and Rationing: Sorting Equilibria in Monopolistic and Competitive Credit Markets," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 28(3), pages 671-89, October.
  6. Anderson, Ronald C. & Mansi, Sattar A. & Reeb, David M., 2003. "Founding family ownership and the agency cost of debt," Journal of Financial Economics, Elsevier, Elsevier, vol. 68(2), pages 263-285, May.
  7. Ken Cavalluzzo & John Wolken, 2005. "Small Business Loan Turndowns, Personal Wealth, and Discrimination," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 78(6), pages 2153-2178, November.
  8. G. S. Maddala & Lung-Fei Lee, 1976. "Recursive Models with Qualitative Endogenous Variables," NBER Chapters, National Bureau of Economic Research, Inc, in: Annals of Economic and Social Measurement, Volume 5, number 4, pages 525-545 National Bureau of Economic Research, Inc.
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