Bankruptcy and Entrepreneurship: The Value of a Fresh Start

This paper considers bankruptcy law design in a setting that is appropriate for entrepreneurial firms. These firms are characterized by a dependence on an owner-manager who is essential to the firm and must be given incentive through an ownership stake to maximize the value of the project. The relationship banks that fund entrepreneurs cannot capture the gains from providing the entrepreneur with this stake and this leaves the entrepreneur emerging from bankruptcy with a larger debt burden than is socially efficient. In this setting, a "fresh start" bankruptcy policy provides greater debt relief than the bank would approve voluntarily, and this generates greater social surplus. The results shed light on the ongoing debate over a separate small-business bankruptcy chapter resembling the current Chapter 13.