Personal bankcuptcy law, wealth and entrepreneurship - Theory and evidence from the introduction of a 'fresh start'

Abstract

A personal bankruptcy law that allows for a “fresh start” after bankruptcy reduces the individual risk involved in entrepreneurial activit y. On the other hand, as risk shifts to creditors who recover less of their credit after a debtor’s bankruptcy, lenders may charge higher interest rates or ration credit supply, whic h can hamper entrepreneurship. Both aspects of a more forgiving personal bankruptcy law are les s relevant for wealthy potential entrepreneurs who still risk losing their wealth, b ut tend not to face higher interest rates because they provide collateral. This paper illustr ates these effects in a model and tests the hypotheses derived by exploiting the introduction o f a “fresh start” policy in Germany in 1999 as a natural experiment, based on representative ho usehold panel data. The results indicate that the insurance effect of a more forgiving perso nal bankruptcy law exceeds the interest effect and on balance encourages less wealthy indiv iduals to enter into entrepreneurship.