The Bankruptcy Reform Act of 2005 and Entrepreneurial Activity


  • I thank Clair Brown, Ulrike Malmendier, David Mowery, Douglas Cumming, and Daniel Spulber and seminar participants at the Searle Research Symposium on the Economics and Law of the Entrepreneur, Entrepreneurial Finance and Innovation Conference, and Marshall School of Business at the University of Southern California for their helpful comments. I also thank the editor and two anonymous reviewers for their insightful comments. I gratefully acknowledge financial support from the Ewing Marion Kauffman Foundation, and the Grief Center for Entrepreneurship at University of Southern California. All errors are mine.


This paper empirically investigates the effect of the Bankruptcy Reform Act of 2005 on entrepreneurial activity. We find that this act had virtually no noticeable effect on the overall level of entrepreneurship, measured by self-employment, partly because potential entrepreneurs were more likely to seek limited liability to offset the reduction in wealth protection imposed by the new law. That is, the incorporation rate increased for small businesses after the new law was enacted. This increase emphasizes that limited liability provided by incorporation is an important strategic variable that potential entrepreneurs utilize in response to changes in personal bankruptcy law. This study implies that incorporation is an important parameter to consider in understanding the relationship between bankruptcy law and entrepreneurial activity. The policy implication of this study is that entrepreneurs do respond to changes in personal bankruptcy law, even though it is intended for consumers, so this potential side effect should be considered when designing a new law.