Bankruptcy and Small Firms' Access to Credit Bankruptcy and Small Firms' Access to Credit

In this paper, we investigate whether and how personal bankruptcy law a ects small rms' access to credit. When a rm is unincorporated, its debts are personal liabilities of the rm's owner, so that lending to the rm is equivalent to lending to its owner. If the rm fails, the owner has an incentive to le for personal bankruptcy in order to obtain discharge of the rm's debts. While bankruptcy law is uniform across the country, states are allowed to set their own bankruptcy exemption levels and they vary widely. The higher the exemption level, the more attractive it is for debtors who live in that state to le for bankruptcy, because they can keep more of their assets while obtaining discharge of their own and the rm's debts. The paper presents a theoretical model of credit markets which shows that supply of credit falls and demand for credit rises when non-corporate rms are located in states with higher bankruptcy exemption levels. We test the model using the NSSBF and nd that high homestead and personal property exemptions exemptions are associated with an increased probability of non-corporate rms being denied credit, but do not a ect the probability of corporate rms being denied credit. We also nd weak evidence that both types of rms receive smaller loans when they are located in states that have high bankruptcy exemptions, but we nd no evidence that interest rates are a ected by bankruptcy exemptions. We also test for the e ect of a prior bankruptcy ling by non-corporate rms or their owners on access to credit and nd that a prior ling nearly triples the probability that these rms are denied credit.