Bankruptcy Law, Debt Portfolios, and Entrepreneurship
AbstractEvery year 400,000 entrepreneurs fail and 60,000 file for personal bankruptcy. The option to declare bankruptcy provides entrepreneurs with insurance against the financial consequences of business failures. However, it comes at the cost of worsened credit market conditions. In this paper, we construct a quantitative general equilibrium model of entrepreneurship to show that the presence of secured credit in addition to unsecured credit substantially alters the trade-off between insurance and credit conditions. A lenient bankruptcy law always worsens credit conditions, in particular for poor entrepreneurs. If secured credit is not available, their credit conditions are so bad that many prefer to become workers. In that case, we show that the optimal bankruptcy law is very harsh because the benefits from better credit conditions dominate the worsened insurance. However, if secured credit is available, entrepreneurs who might be rationed out of the unsecured credit market can still obtain secured credit. Therefore, they can run larger firms, which makes entrepreneurship more attractive. Since the presence of secured credit lowers the cost of a generous bankruptcy law, we find that the optimal law is lenient in this case: moving to the optimal bankruptcy law would increase entrepreneurship by more than four per cent.
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Bibliographic InfoPaper provided by University of St. Gallen, School of Economics and Political Science in its series Economics Working Paper Series with number 1216.
Length: 41 pages
Date of creation: Jul 2012
Date of revision:
Debt portfolio; Bankruptcy; Occupational Choice;
Find related papers by JEL classification:
- M13 - Business Administration and Business Economics; Marketing; Accounting - - Business Administration - - - New Firms; Startups
- K10 - Law and Economics - - Basic Areas of Law - - - General (Constitutional Law)
- O41 - Economic Development, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models
- E20 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data)
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-07-14 (All new papers)
- NEP-ENT-2012-07-14 (Entrepreneurship)
- NEP-LAW-2012-07-14 (Law & Economics)
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