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

TitleAsset exemption in entrepreneurs' bankruptcy and the informative role of collateral
Publication TypeWorking Paper
Year of Publication2016
AuthorsP. Arca, G. Atzeni, LG. Deidda
Number2016_13
Publication Languageeng
ISBN Number978 88 9386 007 9
Keywordscollateral, Cost of credit, Credit rationing, Exemption, Pooling, screening, Separation
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.

Citation Key6769
AttachmentSize
PDF icon wp-16-13.pdf2.06 MB