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

Abstract

Based on the historical record surrounding the Bankruptcy Reform Act of 1978, we ask whether new incentives embedded in a major legal change have their anticipated effect on bankruptcy chapter choice. We focus on incentives leading to an increase in the incidence of reorganizational filings, and ask a set of questions related to such an increase and the apparent change in incentives under the new law. Can a model of household chapter choice explain the growth in the incidence of reorganizational filings after the legal change? Was the increase in Chapter 13 filings a result of differences in debtor circumstances across periods, or was there a change in behavior? Are there direct effects on the probability of choosing Chapter 13 due to the new incentive scheme, and if so, which factors appear to be more important than others? We find a significant change in behavior across legal regimes. The change accounts for a large proportion of the observed growth in reorganizational filings. The sources leading to this increased incidence that also are traceable to changes in the law include cost effects, changes in eligibility requirements across chapters, differences in categories of dischargeable debt, and increased equity protection. A consistent tthread running through the results is that new incentives change behavior, but do so substantively only when large amounts of money are at stake. One implication is that the distribution of property and existing exemption levels should be taken into account in forecasting the likely results of legal policy shifts.

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