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Asset exemption in entrepreneurs' bankruptcy and the informative role of collateral

Author

Listed:
  • P. Arca
  • Gianfranco E. Atzeni
  • LG Deidda

Abstract

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.

Suggested Citation

  • P. Arca & Gianfranco E. Atzeni & LG Deidda, 2016. "Asset exemption in entrepreneurs' bankruptcy and the informative role of collateral," Working Paper CRENoS 201613, Centre for North South Economic Research, University of Cagliari and Sassari, Sardinia.
    • Handle: RePEc:cns:cnscwp:201613
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