Asset Exemption in Entrepreneurs’ Bankruptcy and the Informative Role of Collateral
Working papers CRENOS (Contributi di ricerca), 2016
64 Pages Posted: 28 Oct 2019 Last revised: 31 Oct 2019
Date Written: 2016
If an entrepreneur files for bankruptcy under Chapter 7, (i) most of her debt is discharged, and (ii) only her non-exempt assets are liquidated. Entrepreneurs can undo this “insurance” by posting collateral. The opportunity cost of doing so is lower for safer entrepreneurs who face a lower probability of default. Accordingly, we show that under adverse selection, as exemption increases, collateral becomes a more effective sorting device. As a result, an entrepreneur’s decision to post collateral improves access to credit and reduces the cost of credit to a greater extent the larger the exemption is. Econometric tests using data from the US Survey of Small Business support our theory.
Keywords: Screening, Separation, Pooling, Exemption, Collateral, Credit rationing, Cost of credit
JEL Classification: D82, E51, G33, K35
Suggested Citation: Suggested Citation