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Bankruptcy and Small Firms' Access to Credit

  • Jeremy Berkowitz
  • Michelle J. White
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    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.

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    File URL: http://www.nber.org/papers/w9010.pdf
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    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 9010.

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    Date of creation: Jun 2002
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    Publication status: published as Berkowitz, Jeremy and Michelle J. White. "Bankruptcy and Small Firms' Access to Credit." RAND Journal of Economics 35, 1 (Spring 2004): 69-84.
    Handle: RePEc:nbr:nberwo:9010
    Note: CF LE
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    1. Hart, O. & Moore, J., 1989. "Default And Renegotiation: A Dynamic Model Of Debt," Working papers 520, Massachusetts Institute of Technology (MIT), Department of Economics.
    2. White, M.J., 1998. "Why Don't More Households File for Bankruptcy?," Papers 98-03, Michigan - Center for Research on Economic & Social Theory.
    3. Bester, Helmut, 1994. "The Role of Collateral in a Model of Debt Renegotiation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 26(1), pages 72-86, February.
    4. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
    5. Roger H. Gordon & Jeffrey K. MacKie-Mason, 1992. "Tax Distortions to the Choice of Organizational Form," NBER Working Papers 4227, National Bureau of Economic Research, Inc.
    6. Longhofer, Stanley D., 1997. "Absolute Priority Rule Violations, Credit Rationing, and Efficiency," Journal of Financial Intermediation, Elsevier, vol. 6(3), pages 249-267, July.
    7. Wang, H.J. & White, M., 1998. "An Optimal Personal Bankruptcy Procedure and Proposed Reform," Papers 98-07, Michigan - Center for Research on Economic & Social Theory.
    8. Reint Gropp & John Karl Scholz & Michelle White, 1996. "Personal Bankruptcy and Credit Supply and Demand," NBER Working Papers 5653, National Bureau of Economic Research, Inc.
    9. Rebel A. Cole & Lawrence G. Goldberg & Lawrence J. White, 1999. "Cookie-cutter versus character: the micro structure of small business lending by large and small banks," Proceedings 777, Federal Reserve Bank of Chicago.
    10. Mitchell A. Petersen & Raghuram G. Rajan, 1994. "The Effect of Credit Market Competition on Lending Relationships," NBER Working Papers 4921, National Bureau of Economic Research, Inc.
    11. Berkowitz, Jeremy & Hynes, Richard, 1999. "Bankruptcy Exemptions and the Market for Mortgage Loans," Journal of Law and Economics, University of Chicago Press, vol. 42(2), pages 809-30, October.
    12. Cole, Rebel A., 1998. "The importance of relationships to the availability of credit," Journal of Banking & Finance, Elsevier, vol. 22(6-8), pages 959-977, August.
    13. Stanley D. Longhofer, 1997. "Absolute priority rule violations, credit rationing, and efficiency," Working Paper 9710, Federal Reserve Bank of Cleveland.
    14. Moulton, Brent R., 1986. "Random group effects and the precision of regression estimates," Journal of Econometrics, Elsevier, vol. 32(3), pages 385-397, August.
    15. Ken Cavalluzzo & Linda Cavalluzzo & John Wolken, 1999. "Competition, small business financing, and discrimination: evidence from a new survey," Finance and Economics Discussion Series 1999-25, Board of Governors of the Federal Reserve System (U.S.).
    16. Mitchell A. Petersen & Raghuram G. Rajan, . "Trade Credit: Theories and Evidence," CRSP working papers 322, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    17. 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.
    18. Hynes, Richard M & Malani, Anup & Posner, Eric A, 2004. "The Political Economy of Property Exemption Laws," Journal of Law and Economics, University of Chicago Press, vol. 47(1), pages 19-43, April.
    19. Petersen, Mitchell A & Rajan, Raghuram G, 1994. " The Benefits of Lending Relationships: Evidence from Small Business Data," Journal of Finance, American Finance Association, vol. 49(1), pages 3-37, March.
    20. Berger, Allen N & Udell, Gregory F, 1995. "Relationship Lending and Lines of Credit in Small Firm Finance," The Journal of Business, University of Chicago Press, vol. 68(3), pages 351-81, July.
    21. White, Michelle J, 1998. "Why Don't More Households File for Bankruptcy?," Journal of Law, Economics and Organization, Oxford University Press, vol. 14(2), pages 205-31, October.
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