Bankruptcy and Small Firms' Access to Credit

Jeremy Berkowitz, Michelle J. White

NBER Working Paper No. 9010
Issued in June 2002
NBER Program(s):Corporate Finance, Law and Economics

In this paper, we investigate how personal bankruptcy law affects small firms' access to credit. When a firm is unincorporated, its debts are personal liabilities of the firm's owner, so that lending to the firm is legally equivalent to lending to its owner. If the firm fails, the owner has an incentive to file for personal bankruptcy, since the firm's debts will be discharged and the owner is only obliged to use assets above an exemption level to repay creditors. The higher the exemption level, the greater is the incentive to file for bankruptcy. We show that supply of credit falls and demand for credit rises when non-corporate firms are located in states with higher bankruptcy exemptions. We test the model and find that, if small firms are located in states with unlimited rather than low homestead exemptions, they are more likely to be denied credit, they receive smaller loans and interest rates are higher. Results for non-corporate versus corporate firms suggest that lenders often disregard small firms' organizational status in making loan decisions.

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Document Object Identifier (DOI): 10.3386/w9010

Published: Berkowitz, Jeremy and Michelle J. White. "Bankruptcy and Small Firms' Access to Credit." RAND Journal of Economics 35, 1 (Spring 2004): 69-84.

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