Bankruptcy Laws and Entrepreneur-Friendliness

By Peng, Mike W.; Yamakawa, Yasuhiro et al. | Entrepreneurship: Theory and Practice, May 2010 | Go to article overview

Bankruptcy Laws and Entrepreneur-Friendliness


Peng, Mike W., Yamakawa, Yasuhiro, Lee, Seung-Hyun, Entrepreneurship: Theory and Practice


Using bankruptcy laws as a case of formal institutions, we show how formal institutions impact entrepreneurship development. Historically, bankruptcy laws usually have been harsh. Recently, many governments have realized that entrepreneur-friendly bankruptcy laws can not only lower exit barriers, but also lower entry barriers for entrepreneurs. Since bankruptcy laws are not uniform around the world, it is important to understand how they differ in their friendliness to entrepreneurs. This article focuses on six dimensions of entrepreneur-friendliness: (1) the availability of a reorganization bankruptcy option, (2) the time spent on bankruptcy procedures, (3) the cost of bankruptcy procedures, (4) the opportunity to have a fresh start in liquidation bankruptcy, (5) the opportunity to have an automatic stay of assets during reorganization bankruptcy, and (6) the opportunity for entrepreneurs and managers to remain on the job after filing for bankruptcy. In an effort to cover both developed and emerging economies and to draw on geographically diverse examples, we use data from Australia, Canada, Chile, Finland, Hong Kong, Japan, Norway, Peru, Singapore, South Korea, Thailand, the United States, and other countries to illustrate these differences. Overall, this article contributes to the institution-based view of entrepreneurship by highlighting the important role that formal institutions such as bankruptcy laws play behind entrepreneurship development around the world.

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In entrepreneurship practice and research, institutions matter (Baumol, 1996; North, 1990; Scott, 1995; Yamakawa, Peng, & Deeds, 2008). Market-friendly institutions generally facilitate more vibrant entrepreneurship development, which, in the aggregate, would translate into economic development (Baumol; North). Moving from this widely accepted and thus uncontroversial proposition that institutions matter, the next generation of research on the institution-based view of entrepreneurship needs to probe into how institutions matter (Peng, 2003; Peng, Lee, & Wang, 2005; Peng, Wang, & Jiang, 2008). Following Lee, Peng, and Barney (2007), we argue that whether bankruptcy laws are entrepreneur-friendly has a direct bearing on the level of entrepreneurship development at the societal level. (1) Specifically, this article focuses on the impact of corporate bankruptcy laws (hereafter labeled "bankruptcy laws" for compositional simplicity)--a crucial formal institution governing the insolvency of entrepreneurial firms that has been largely neglected in entrepreneurship research. (2)

Starting up an entrepreneurial firm is a risky and uncertain endeavor that has very strong likelihood of ending in bankruptcy. While the small number of successful entrepreneurs and their firms receive disproportionate scholarly and media attention, a sad and predictable fact is that a majority of entrepreneurial firms end up in bankruptcy. (3) Given that most governments encourage more entrepreneurial start-ups and that most such start-ups fail, societies that are friendlier and more forgiving to failed entrepreneurs are likely to attract more individuals to start up new ventures and to have stronger economic development that comes with vibrant entrepreneurial activities. Conversely, societies that are harsher to failed entrepreneurs whose start-ups end up in bankruptcy will discourage entrepreneurship development. Therefore, in the context of bankruptcy laws, we define "entrepreneur-friendliness" as bankruptcy laws' disposition to be friendly, helpful, and forgiving to entrepreneurs whose firms are bankrupt.

Historically, entrepreneur friendliness and bankruptcy laws are like an "oxymoron," because bankruptcy laws are usually harsh and even cruel. The very term "bankruptcy" is derived from a harsh practice: In medieval Italy, if bankrupt entrepreneurs did not pay their debt, debtors would destroy the trading bench of the bankrupt--the Italian word for broken bench, "banca rotta," has evolved to become the English word "bankruptcy. …

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