Personal Bankruptcy Law, Wealth andEntrepreneurship: Theory and Evidencefrom the Introduction of a “Fresh Start”

A personal bankruptcy law that allows for a “fresh start” after bankruptcy reduces theindividual risk involved in entrepreneurial activity. On the other hand, as risk shifts to creditorswho recover less of their credit after a debtor’s bankruptcy, lenders may charge higherinterest rates or ration credit supply, which can hamper entrepreneurship. Both aspects of amore forgiving personal bankruptcy law are less relevant for wealthy potential entrepreneurswho still risk losing their wealth, but tend not to face higher interest rates because theyprovide collateral. This paper illustrates these effects in a model and tests the hypothesesderived by exploiting the introduction of a “fresh start” policy in Germany in 1999 as a naturalexperiment, based on representative household panel data. The results indicate that theinsurance effect of a more forgiving personal bankruptcy law exceeds the interest effect andon balance encourages less wealthy individuals to enter into entrepreneurship....