The Bankruptcy Decision: Does Stigma Matter?

Abstract

In this paper, we model and estimate the effects of both bankruptcy stigma and financial benefit on households' decisions to file for bankruptcy. We show that the probability of debtors filing for bankruptcy rises when the level of bankruptcy stigma falls. We also show that the level of bankruptcy stigma has external effects, so that individual households are better off if their own bankruptcy stigma level is lower than that of others in the same credit pool and are worse off if their own bankruptcy stigma level is higher than that of others in the same credit pool. Using new data, we find that the probability of filing for bankruptcy is positively and significantly related to the financial benefit from filing. If households' financial benefit from bankruptcy rose by $1,000, the model predicts that the number of filings would rise by 2.8%. As an inverse proxy for the level of bankruptcy stigma, we use the aggregate filing rate in households' state of residence over the past three years, corrected for state fixed effects. We find that this measure is positively and significantly related to the probability of filing for bankruptcy. According to the model, if the bankruptcy filing rate in a particular state doubled, the reduction in the level of bankruptcy stigma would cause the state's filing rate to increase by an additional 19% in the following year. Finally, our model predicts that if the 1997 National Bankruptcy Review Commission's proposed increases in bankruptcy exemption levels were implemented, then the number of bankruptcy filings would increase by about 89,000 per year.