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Bankruptcy and Small Firms' Access to Credit

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  • Jeremy Berkowitz
  • Michelle J. White

Abstract

In this paper, we investigate how personal bankruptcy law affects small firms' access to credit. When a firm is unincorporated, its debts are personal liabilities of the firm's owner, so that lending to the firm is legally equivalent to lending to its owner. If the firm fails, the owner has an incentive to file for personal bankruptcy, since the firm's debts will be discharged and the owner is only obliged to use assets above an exemption level to repay creditors. The higher the exemption level, the greater is the incentive to file for bankruptcy. We show that supply of credit falls and demand for credit rises when non-corporate firms are located in states with higher bankruptcy exemptions. We test the model and find that, if small firms are located in states with unlimited rather than low homestead exemptions, they are more likely to be denied credit, they receive smaller loans and interest rates are higher. Results for non-corporate versus corporate firms suggest that lenders often disregard small firms' organizational status in making loan decisions.

Suggested Citation

  • Jeremy Berkowitz & Michelle J. White, 2002. "Bankruptcy and Small Firms' Access to Credit," NBER Working Papers 9010, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:9010
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    References listed on IDEAS

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    Cited by:

    1. Joydeep Bhattacharya & Shankha Chakraborty, 2005. "What do information frictions do?," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 26(3), pages 651-675, October.
    2. HOSONO Kaoru, 2009. "Financial Crisis, Firm Dynamics and Aggregate Productivity in Japan," Discussion papers 09012, Research Institute of Economy, Trade and Industry (RIETI).
    3. Wei Fan & Michelle J. White, 2002. "Personal Bankruptcy and the Level of Entrepreneurial Activity," NBER Working Papers 9340, National Bureau of Economic Research, Inc.
    4. Dilip Mookherjee & Ulf von Lilienfeld-Toal, 2005. "Bankruptcy Law, Bonded Labor and Inequality," Boston University - Department of Economics - The Institute for Economic Development Working Papers Series DP-155, Boston University - Department of Economics.
    5. repec:hrv:faseco:33078969 is not listed on IDEAS
    6. Loayza, Norman V. & Oviedo, Ana Maria & Serven, Luis, 2005. "Regulation and macroeconomic performance," Policy Research Working Paper Series 3469, The World Bank.
    7. HOSONO Kaoru & XU Peng, 2009. "Do Banks Have Private Information? Bank screening and ex-post small firm performance," Discussion papers 09016, Research Institute of Economy, Trade and Industry (RIETI).
    8. Dilip Mookherjee, 2006. "Decentralization, Hierarchies, and Incentives: A Mechanism Design Perspective," Journal of Economic Literature, American Economic Association, vol. 44(2), pages 367-390, June.
    9. Yannis Georgellis & Howard J. Wall, 2006. "Entrepreneurship and the policy environment," Review, Federal Reserve Bank of St. Louis, vol. 88(Mar), pages 95-112.
    10. Andrei Shleifer, 2003. "Will the Sovereign Debt Market Survive?," American Economic Review, American Economic Association, vol. 93(2), pages 85-90, May.
    11. Fajnzylber, Pablo & Maloney, William F. & Rojas, Gabriel V. Montes, 2006. "Releasing constraints to growth or pushing on a string ? the impact of credit, training, business associations, and taxes on the performance of Mexican micro-firms," Policy Research Working Paper Series 3807, The World Bank.

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    JEL classification:

    • K2 - Law and Economics - - Regulation and Business Law
    • E5 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit

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