Incentives and Bankruptcy Chapter
Choice: Evidence from the Reform
Act of 1978
Ian
Domowitz and Robert L. Sartain
Abstract
We ask two related questions relevant to current public
policy debates concerning personal bankruptcy: What are the important
influences in determining bankruptcy chapter choice, and do new
incentives embedded in a major legal change have their anticipated
impact? Chapter choice models, differentiated between business-related
and nonbusiness bankruptcies, are formulated and estimated with
household data gathered both before and after the 1978 Bankruptcy
Reform Act.
The models predict a substantial portion of the increase in the
proportion of reorganizational filings. Testing confirms a shift
in behavior across legal regimes, as opposed to explanations based
simply on increased eligibility for filing under reorganization
or changes in debtor circumstances. Thus, an answer to the incentive
question depends upon the identification of the important influences
on chapter choice.
The sources promoting the increased incidence of reorganizational
filings traceable to the law lie in cost effects, differences in
categories of dischargeable debt, and increased equity protection
under Chapter 13 of the new law. The importance of exemptions on
the probability of reorganization decreases under the Code, suggesting
that equity incentive effects outweigh disincentives to declare
bankruptcy under Chapter 13 due to the more expansive exemptions
available. Increased eligibility for business filings in reorganization
also plays a role. On the other hand, there are influences relating
to debt, which are not directly explainable through the legal changes.
We quantify the impact of increases in various sources of debt,
and find that unsecured debt, particularly credit card usage, is
important, both in explaining chapter choice and in contributing
to the rise in reorganizational filings.
Ian Domowitz, Currently,
School of Business Administration, Penn State University
Robert L. Sartain, Abt Associates
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