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Incentives and Bankruptcy Chapter Choice: Evidence from the Reform Act of 1978

  • Ian Domowitz
  • Robert L. Sartain

We ask two related questions relevant to current public policy debates concerning personal bankruptcy: What are the important influences in determining bankruptcy chapter choice, and do new incentives embedded in a major legal change have their anticipated impact? Chapter choice models, differentiated between business-related and nonbusiness bankruptcies, are formulated and estimated with household data gathered both before and after the 1978 Bankruptcy Reform Act. The models predict a substantial portion of the increase in the proportion of reorganizational filings. Testing confirms a shift in behavior across legal regimes, as opposed to explanations based simply on increased eligibility for filing under reorganization or changes in debtor circumstances. Thus, an answer to the incentive question depends upon the identification of the important influences on chapter choice. The sources promoting the increased incidence of reorganizational filings traceable to the law lie in cost effects, differences in categories of dischargeable debt, and increased equity protection under Chapter 13 of the new law. The importance of exemptions on the probability of reorganization decreases under the Code, suggesting that equity incentive effects outweigh disincentives to declare bankruptcy under Chapter 13 due to the more expansive exemptions available. Increased eligibility for business filings in reorganization also plays a role. On the other hand, there are influences relating to debt, which are not directly explainable through the legal changes. We quantify the impact of increases in various sources of debt, and find that unsecured debt, particularly credit card usage, is important, both in explaining chapter choice and in contributing to the rise in reorganizational filings.

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Paper provided by Institute for Policy Resarch at Northwestern University in its series IPR working papers with number 98-7.

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Handle: RePEc:wop:nwuipr:98-7
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