Bankruptcy and Small Firms' Access to Credit

We investigate how personal bankruptcy law affects small firms' access to credit. When a firm is unincorporated, its debts are personal liabilities of the firm's owner, so that lending to the firm is legally equivalent to lending to its owner If the firm fails, the owner has an incentive to file for personal bankruptcy, since the firm's debts will be discharged. The higher the exemption level, the greater the incentive to file for bankruptcy. We test the model and find that if small firms are located in states with unlimited rather than low homestead exemptions, they are more likely to be denied credit, and when loans are made, they are smaller and interest rates are higher Results for noncorporate versus corporate firms suggest that lenders often disregard small firms' organizational status in making loan decisions.