The Impact of Bankruptcy Laws on the Entrepreneurial Decision: Are Entrepreneurs Even Aware?

By Kaufmann, Jeffrey B.; Herrmann, Pol et al. | Journal of Applied Management and Entrepreneurship, October 2007 | Go to article overview

The Impact of Bankruptcy Laws on the Entrepreneurial Decision: Are Entrepreneurs Even Aware?


Kaufmann, Jeffrey B., Herrmann, Pol, Van Auken, Howard, Journal of Applied Management and Entrepreneurship


Executive Summary

Central to the kaleidoscope perspective of entrepreneurial careers is the idea of balance. Part of this balance is managing the tension between the risks inherent in the entrepreneurial effort and the need to financially protect the entrepreneur's family and other obligations. States can help entrepreneurs manage this tension by exempting certain property from bankruptcy thereby offering these economic actors some financial protection should the effort fail. Several recent studies have identified a link between these exemptions to federal bankruptcy law and rates of entrepreneurship. These studies presume, however, that the state exemptions provide a level of wealth insurance should the entrepreneurial effort fail and that this is factored into the decision to start a new venture. Using data from a questionnaire sent to entrepreneurs, our study examines this presumption and finds that it is not warranted; that entrepreneurs are generally unaware of the existence of these exemptions when deciding whether to start a new venture. We conclude by discussing the implications of our findings for both scholars and policy makers who desire to increase rates of entrepreneurship within their domains.

Introduction

Central to the kaleidoscope perspective of entrepreneurial careers is the idea of balance. Balance, in this context, refers to the entrepreneurs' need to fit their entrepreneurial activities into the other parts of their life to create a coherent whole (Mainiero & Sullivan, 2005). One major consideration in achieving this balance involves the successful management of the tension between the risks inherent in the entrepreneurial effort and the need to financially protect the entrepreneur's family and fulfill his or her other financial obligations. States can help entrepreneurs manage this tension by protecting certain economic property should the effort fail and the entrepreneur find him or herself facing federal bankruptcy proceedings.

The relationship between bankruptcy protections and the decision to engage in entrepreneurial activity has been the subject of considerable interest over the past few years. Much of this interest stems from the recognition that entrepreneurial activity is an important component of economic growth (Craig, Jackson & Thomson, 2003) and that governmental policies impact rates of entrepreneurship (Armour & Cumming, 2005). Indeed, several empirical studies looking at the impact of bankruptcy laws on entrepreneurship have shown that a relationship between the two does exist (e.g., Fan & White, 2003; Georgellis & Wall, 2006; Mather, 2005). By implication then, it would seem that governments can increase the level of local entrepreneurship through changes in the rules surrounding bankruptcy (Colasanti, 2003). While this may be true, the relationship between these areas is not well understood. In particular, it is not yet understood whether such changes impact the decision to engage in entrepreneurial activity directly or are reflective of a more generally conducive economic climate for business start-ups. While the underlying presumption of previous studies is that entrepreneurs take failure into consideration and are influenced by the downside protections offered by the state, this presumption has never been studied.

Understanding the accuracy of the above presumption may have important implications for both entrepreneurs and governmental bodies seeking to encourage entrepreneurial activity. For the former, Carraher and colleagues argue that an uncertain operating environment creates a set of unique demands for small firms that require timely information and flexibility in decision making (Carraher et al, 2006) and that greater information within a small business improves performance (Carraher & Buckley, 2005). Therefore, understanding the benefits of state provided wealth insurance through exemptions to bankruptcy should also enable these economic actors to more easily achieve the level of balance necessary to successfully undertake entrepreneurial activity. …

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