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Bankruptcy and Entrepreneurship: The Value of a Fresh Start

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  • Kenneth Ayotte

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.

Suggested Citation

  • Kenneth Ayotte, 2007. "Bankruptcy and Entrepreneurship: The Value of a Fresh Start," Journal of Law, Economics, and Organization, Oxford University Press, vol. 23(1), pages 161-185, April.
  • Handle: RePEc:oup:jleorg:v:23:y:2007:i:1:p:161-185
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    File URL: http://hdl.handle.net/10.1093/jleo/ewm007
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    Cited by:

    1. 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.
    2. Erkko Autio & Kun Fu, 2015. "Economic and political institutions and entry into formal and informal entrepreneurship," Asia Pacific Journal of Management, Springer, vol. 32(1), pages 67-94, March.
    3. Frank M. Fossen & Johannes König, 2016. "Personal Bankruptcy Law and Entrepreneurship," ifo DICE Report, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 13(4), pages 28-34, 02.
    4. 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.
    5. repec:ces:ifodic:v:13:y:2016:i:4:p:19191583 is not listed on IDEAS
    6. Bond, Philip & Newman, Andrew F., 2009. "Prohibitions on punishments in private contracts," Journal of Financial Intermediation, Elsevier, vol. 18(4), pages 526-540, October.
    7. Primo David M. & Green Wm Scott, 2011. "Bankruptcy Law and Entrepreneurship," Entrepreneurship Research Journal, De Gruyter, vol. 1(2), pages 1-22, March.
    8. Lee, Seung-Hyun & Peng, Mike W. & Song, Sangcheol, 2013. "Governments, entrepreneurs, and positive externalities: A real options perspective," European Management Journal, Elsevier, vol. 31(4), pages 333-347.
    9. repec:spr:manint:v:52:y:2012:i:1:d:10.1007_s11575-011-0112-1 is not listed on IDEAS

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