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Bankruptcy, Incorporation and the Nature of Entrepreneurial Risk

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Listed:
  • Jacob M. Short

    (University of Western Ontario)

  • Andy Glover

    (University of Minnesota)

Abstract

Entrepreneurship is risky; entrepreneurs forgo wages and invest their time and resources into a business with large potential gains, but uninsurable risks. It is vital to know the extent of these risks, and the insurance available against them, in order to assess corporate tax and personal bankruptcy reforms. We document that incorporated entrepreneurs operate larger businesses, accumulate more wealth, and are on average more productive than unincorporated entrepreneurs. We embed the U.S. bankruptcy and incorporation legal systems in a quantitative macroeconomic theory of occupation, incorporation, and default choices that accounts for the cross-sectional facts. In the model, as in the U.S., incorporation provides insurance via limited liability beyond personal bankruptcy exemptions, at the expense of administrative burdens and an endogenous interest rate premium. Our model suggests that capital embodied shocks are important entrepreneurial risks. A calibrated economy in which each unit of installed capital entails a small probability (1.0%) of a catastrophic shock (full destruction of capital) is able to account for the data along multiple untargeted dimensions. We find the welfare gains for entrepreneurs from eliminating investment risk are huge (5.9% increase in annual consumption). And, the welfare loss from removing limited liability to be large.

Suggested Citation

  • Jacob M. Short & Andy Glover, 2011. "Bankruptcy, Incorporation and the Nature of Entrepreneurial Risk," 2011 Meeting Papers 836, Society for Economic Dynamics.
  • Handle: RePEc:red:sed011:836
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    References listed on IDEAS

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    1. Marco Cagetti & Mariacristina De Nardi, 2006. "Entrepreneurship, Frictions, and Wealth," Journal of Political Economy, University of Chicago Press, vol. 114(5), pages 835-870, October.
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    4. Akyol, Ahmet & Athreya, Kartik, 2011. "Credit and self-employment," Journal of Economic Dynamics and Control, Elsevier, vol. 35(3), pages 363-385, March.
    5. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & José-Víctor Ríos-Rull, 2007. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Econometrica, Econometric Society, vol. 75(6), pages 1525-1589, November.
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    7. Bebchuk, Lucian Arye & Cohen, Alma, 2003. "Firms' Decisions Where to Incorporate," Journal of Law and Economics, University of Chicago Press, vol. 46(2), pages 383-425, October.
    8. Storesletten, Kjetil & Telmer, Chris I. & Yaron, Amir, 2001. "The welfare cost of business cycles revisited: Finite lives and cyclical variation in idiosyncratic risk," European Economic Review, Elsevier, vol. 45(7), pages 1311-1339.
    9. Fan, Wei & White, Michelle J, 2003. "Personal Bankruptcy and the Level of Entrepreneurial Activity," Journal of Law and Economics, University of Chicago Press, vol. 46(2), pages 543-567, October.
    10. Neus Herranz & Stefan Krasa & Anne P. Villamil, 2009. "Entrepreneurs, Legal Institutions and Firm Dynamics," Centre for Growth and Business Cycle Research Discussion Paper Series 128, Economics, The Univeristy of Manchester.
    11. Césaire A. Meh & Yaz Terajima, 2008. "Unsecured Debt, Consumer Bankruptcy, and Small Business," Staff Working Papers 08-5, Bank of Canada.
    12. Sumit Agarwal & Souphala Chomsisengphet & Chunlin Liu & Lawrence Mielnicki, 2005. "Impact of State Exemption Laws on Small Business Bankruptcy Decision," Southern Economic Journal, Southern Economic Association, vol. 71(3), pages 620-635, January.
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    Cited by:

    1. Fatih Guvenen, 2011. "Macroeconomics with hetereogeneity : a practical guide," Economic Quarterly, Federal Reserve Bank of Richmond, issue 3Q, pages 255-326.
    2. Kyle Herkenhoff & Gordon Phillips & Ethan Cohen-Cole, 2017. "The Impact of Consumer Credit Access on Employment, Earnings, and Entrepreneurship," Working Papers 2017-011, Human Capital and Economic Opportunity Working Group.
    3. Kyle Herkenhoff & Gordon Phillips & Ethan Cohen-Cole, 2016. "The Impact of Consumer Credit Access on Employment, Earnings and Entrepreneurship," NBER Working Papers 22846, National Bureau of Economic Research, Inc.
    4. Mariacristina De Nardi, 2015. "Quantitative Models of Wealth Inequality: A Survey," NBER Working Papers 21106, National Bureau of Economic Research, Inc.
    5. Mankart, Jochen & Rodano, Giacomo, 2015. "Personal bankruptcy law, debt portfolios, and entrepreneurship," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 157-172.
    6. Neus Herranz & Stefan Krasa & Anne P. Villamil, 2015. "Entrepreneurs, Risk Aversion, and Dynamic Firms," Journal of Political Economy, University of Chicago Press, vol. 123(5), pages 1133-1176.
    7. repec:red:issued:16-340 is not listed on IDEAS
    8. Mariacristina De Nardi & Giulio Fella, 2017. "Saving and Wealth Inequality," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 280-300, October.
    9. Neus Herranz, & Stefan Krasa, & Anne P. Villamil, 2013. "Entrepreneurs, Risk Aversion and Dynamic Firms," Centre for Growth and Business Cycle Research Discussion Paper Series 189, Economics, The Univeristy of Manchester.
    10. Neus Herranz & Stefan Krasa & Anne P. Villamil, 2017. "Entrepreneurs, legal institutions and firm dynamics," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(1), pages 263-285, January.

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