How Does Personal Bankruptcy Law Affect Startups?

Abstract

We analyze the effect of changes in U.S. state personal exemptions on the financing structure and performance of a representative sample of start-ups. An increase in the amount of borrower's personal wealth protected in bankruptcy reduces the availability of bank credit to all start-ups. Owners of unlimited liability businesses, who benefit from the increase in wealth insurance, offset the reduction in bank credit by investing more money in the firm.We find no such response for start-ups whose entrepreneurs' personal wealth is already protected by limited liability. Consequently, corporations experience lower growth rates and higher failure rates, while proprietorships performance is not negatively affected.

Do Bankruptcy Protection Levels Affect Households' Demand for Stocks?

“…The lobbyists for higher exemptions are typically attorneys and law firms, who benefit from debt-related litigation, whereas banks and collectors lobby against debtor protection. As also shown by Cerqueiro and Penas (2016) and Severino and Brown (2017), I verify that the most likely sources of contemporaneous shocks are not significantly related to the exemption level and, therefore, changes in exemptions can be taken as plausibly exogenous.…”

“…It can be threatened if their determinants are also driving stock market participation. According to Cerqueiro and Penas (2016), the level of protection was typically changed to keep up with increasing home prices and rising medical costs. Another reason was the purpose to match higher exemptions in neighboring states that attracted "deadbeat" filers, who would transfer their exemptible assets.…”

The recent financial crisis, start‐up financing and survival

“…In many countries, start-ups are not required to publicly disclose their financial statements. Data scarcity explains why relatively few scholars have investigated the financing of start-ups, or have relied on (survey) data of start-ups founded in one particular year (e.g., Cerqueiro & Penas, 2016;Cole & Sokolyk, 2018;Robb & Robinson, 2014, all rely on startups founded in 2004), or have focused on non-random samples of start-ups applying for financing at one particular financial institution (e.g., Cressy, 1996;Fracassi, Garmaise, Kogan, & Natividad, 2016). We take advantage of the Belgian setting, where all non-financial firms have a legal obligation to annually file their financial statements, to construct a comprehensive sample of start-ups founded before and during the recent financial crisis.…”

Personal Bankruptcy Laws and Corporate Policies

“…Studies along this line focus on the effects on entrepreneurial firms. For example, Fan and White (2003) show that more forgiving bankruptcy laws spur entrepreneurial activity; Cerqueiro and Penas (2017) find that an increase in state-level debtor exemption limits in personal bankruptcy laws results in reduced employment, access to credit, and performance of firms owned by mid-wealth entrepreneurs. Our results extend these findings by showing that personal bankruptcy laws affect corporate policies of large, publicly listed companies.…”