Personal Bankruptcy and the Level of Entrepreneurial Activity

Working Paper No. 2000-02

38 Pages Posted: 14 Apr 2000

See all articles by Wei Fan

Wei Fan

University of Michigan at Ann Arbor - Department of Economics

Michelle J. White

University of California, San Diego (UCSD) - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: March 2000

Abstract

The U.S. personal bankruptcy system functions as a bankruptcy system for small businesses as well as for consumers. When firms are non-corporate, debts of the firm are personal liabilities of the entrepreneur/owner. If the firm fails, the entrepreneur has an incentive to file for bankruptcy under Chapter 7, since both business debts and the entrepreneur's personal debts will be discharged. The entrepreneur must give up assets above a fixed bankruptcy exemption level for repayment to creditors, but future earnings are entirely exempt. Exemption levels are set by the states and they vary widely.

We show that higher bankruptcy exemption levels benefit potential entrepreneurs by providing partial wealth insurance. This means that the predicted relationship between the probability of owning a business and the exemption level is positive at low exemption levels, but may be either positive or negative at high exemption levels, depending on whether higher bankruptcy costs outweigh the gain from additional insurance. We test this prediction and find evidence that the probability of owning a business is about 28% higher if potential entrepreneurs live in states with unlimited exemptions rather than low exemptions. We also find evidence that families are significantly more likely to start businesses if they live in states with high or unlimited, rather than low, bankruptcy exemptions. They are also more likely to organize their businesses as non-corporate rather than corporate if they live in states with high exemptions.

JEL Classification: E6, K2, M13, L5

Suggested Citation

Fan, Wei and White, Michelle J., Personal Bankruptcy and the Level of Entrepreneurial Activity (March 2000). Working Paper No. 2000-02. Available at SSRN: https://ssrn.com/abstract=221948 or http://dx.doi.org/10.2139/ssrn.221948

Wei Fan

University of Michigan at Ann Arbor - Department of Economics ( email )

611 Tappan Street
Ann Arbor, MI 48109-1220
United States
734-483-7286 (Phone)
734-764-2769 (Fax)

Michelle J. White (Contact Author)

University of California, San Diego (UCSD) - Department of Economics ( email )

9500 Gilman Drive
La Jolla, CA 92093-0508
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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