The Bankruptcy Reform Act of 2005 and Entrepreneurial Activity

Abstract

This paper empirically investigates the effect of the Bankruptcy Reform Act of 2005 on entrepreneurial activity. We find that this act had virtually no noticeable effect on the overall level of entrepreneurship, measured by self‐employment, partly because potential entrepreneurs were more likely to seek limited liability to offset the reduction in wealth protection imposed by the new law. That is, the incorporation rate increased for small businesses after the new law was enacted. This increase emphasizes that limited liability provided by incorporation is an important strategic variable that potential entrepreneurs utilize in response to changes in personal bankruptcy law. This study implies that incorporation is an important parameter to consider in understanding the relationship between bankruptcy law and entrepreneurial activity. The policy implication of this study is that entrepreneurs do respond to changes in personal bankruptcy law, even though it is intended for consumers, so this potential side effect should be considered when designing a new law.

Health Insurance, Job Lock, and the Supply of Self-Employment

“…The tables show all results to remain qualitatively unchanged showing no significant impact of the 2005 change in bankruptcy laws on health‐care status. Our results are also consistent with recent works (Paik ) showing that the Bankruptcy Reform Act of 2005 had no noticeable effect on the overall level of self‐employment largely because self‐employed individuals were more likely to seek the limited liability offered by incorporation as a way of offsetting the decrease in wealth protection caused by the new law.…”

“…Sixth, we consider the possibility of bias introduced by omitted institutional variables should be considered when interpreting the results. To account for this potential problem, we considered the significant change in U.S. bankruptcy laws implemented in 2005 (Paik ) as an example of a major institutional change that took place during the period covered by our data and could have had an impact on our results. Thus, we re‐estimated Tables excluding all observations after 2005.…”

“…Similarly, Paik () found that, although the Bankruptcy Reform Act of 2005 had no noticeable effect on the overall level of self‐employment, this was largely because self‐employed individuals were more likely to seek the limited liability offered by incorporation as a way of offsetting the decrease in wealth protection caused by the new law. In other words, Paik results show that insurance, broadly defined, and changes in its status, may result in an adjustment of behavior within the boundary of the considered institution (more incorporation of small businesses) but produce no change with respect to the overall behavior of the population (overall amount of self‐employment did not change).…”

Unleashing private sector productivity in the United States

“…Although failed entrepreneurs can still opt for Chapter 11 bankruptcy, this route is more onerous because it requires the filer to set out a repayment schedule, thereby heightening risks that entrepreneurs would be saddled with debt repayment obligations if they were to fail. Indirect evidence suggests that this change may have raised the implicit costs of starting a business ( Figure 12), prompting a noticeable overall decline in personal bankruptcy filings prior to the financial crisis, and encouraging a shift in ownership from sole proprietorships and partnerships toward the more costly option of incorporation (Paik, 2013). States that have offered exemptions for the new Chapter 7 rules have done comparatively better than other States in generating firm creation (Rohlin and Ross, 2016), suggesting that more onerous personal bankruptcy rules have inhibited firm creation.…”

The state‐level exemption changes in Chapter 7 protection and entrepreneurial activity in the United States

“…However, considering more business-friendly bankruptcy laws, debtors would also ration credit and increase the cost of debt, thus limiting the growth potential of a business. Whether business-friendly bankruptcy laws favor entrepreneurial activity has received mixed support (Paik, 2013), yet bankruptcy laws are a key policy input in promoting entrepreneurship (Armour & Cumming, 2008). Rohlin and Ross (2016) examine how the differences in 2004, 2006, and 2009 homestead exemptions by US states influence new and existing business turnover.…”