Description
How Do Bankruptcy Laws Affect Entrepreneurship Development Around The World
How do bankruptcy laws affect entrepreneurship development around
the world?
Seung-Hyun Lee
a,1
, Yasuhiro Yamakawa
b,
?, Mike W. Peng
a,2
, Jay B. Barney
c,3
a
University of Texas at Dallas, School of Management, 800 West Campbell, SM 43, Richardson, TX 75080, United States
b
Babson College, Arthur M. Blank Center for Entrepreneurship, Babson Park, MA 02457, United States
c
The Ohio State University, Fisher College of Business, 2100 Neil Avenue, Columbus, OH 43210, United States
a r t i c l e i n f o a b s t r a c t
Article history:
Received 20 May 2009
Received in revised form 26 April 2010
Accepted 18 May 2010
Available online 26 June 2010
How do bankruptcy laws as formal institutions affect entrepreneurship development around
the world? Do entrepreneur-friendly bankruptcy laws encourage more entrepreneurship
development at a societal level? We posit that if bankrupt entrepreneurs are excessively
punished for failure, they may give up potentially high-return but inherently high-risk oppor-
tunities to start newbusinesses. Amassing a cross-country database from29 countries spanning
19 years (1990–2008), we ?nd that lenient, entrepreneur-friendly bankruptcy laws are signif-
icantly correlated with the level of entrepreneurship development as measured by the rate of
new ?rm entry.
© 2010 Elsevier Inc. All rights reserved.
Keywords:
Bankruptcy laws
Entrepreneurship
Institutions
Institution-based view
1. Executive summary
Corporate bankruptcies are common. While all entrepreneurs are interested in success, unfortunately a majority of their
ventures fail and many end up in bankruptcy. A challenge confronting policymakers around the world is: How to facilitate more
entrepreneurship development in the face of such odds against entrepreneurial success?
How formal institutions of a society, such as bankruptcy laws, govern bankrupt entrepreneurs and ?rms is an important
component of the institutional framework within which entrepreneurs and ?rms operate. The legal procedures associated with
bankruptcy vary signi?cantly across countries. Some countries provide only limited protection for entrepreneurs and managers of
bankrupt ?rms, while others have more entrepreneur-friendly bankruptcy laws.
A well-known proposition in the literature is that institutions matter—more speci?cally, entrepreneurs and ?rms strategically
respond to the institutional incentives and disincentives. Given the “institutions matter” proposition, more work is needed to help
us understand: How do institutions matter? Thus, two important but unexplored questions we investigate in this study are: How
do bankruptcy laws affect entrepreneurship development aroundthe world? Do entrepreneur-friendly bankruptcy laws encourage
more entrepreneurship development at a societal level?
Amassing a longitudinal, cross-country database covering 29 countries and spanning 19 years (1990–2008, inclusive), we focus
on whether differences in bankruptcy laws are systematically related to the different levels of entrepreneurship development as
measured by the rate of new ?rm entry. Components of entrepreneur-friendly bankruptcy laws include: (1) the time spent on
bankruptcy procedure, (2) the cost of bankruptcy procedure, (3) the opportunity to have a fresh start in liquidation bankruptcy,
Journal of Business Venturing 26 (2011) 505–520
? Corresponding author. Tel.: +1 781 239 4747; fax: +1 781 239 4178.
E-mail addresses: [email protected] (S.-H. Lee), [email protected] (Y. Yamakawa), [email protected] (M.W. Peng), [email protected]
(J.B. Barney).
1
Tel.: +1 972 883 6267; fax: +1 972 883 2799.
2
Tel.: +1 972 883 2714; fax: +1 972 883 6029.
3
Tel.: +1 614 688 3161; fax: +1 614 292 3172.
0883-9026/$ – see front matter © 2010 Elsevier Inc. All rights reserved.
doi:10.1016/j.jbusvent.2010.05.001
Contents lists available at ScienceDirect
Journal of Business Venturing
(4) the opportunity to have an automatic stay of assets, and (5) the opportunity for managers to remain on the job after ?ling for
bankruptcy. By examining the relationship between bankruptcy laws and the value creating activities in a society associated with
new ?rm formation, we predict that entrepreneur-friendly bankruptcy laws may increase the rate of new ?rm entry, which may
be indicative of vibrant entrepreneurial activities in an economy.
Contributing to an institution-based view of entrepreneurship, our research has clear implications for policymakers interested
in entrepreneurship development in an economy and for entrepreneurs assessing their risk when starting up new ?rms. For
policymakers, we suggest that making bankruptcy laws more entrepreneur-friendly will positively affect entrepreneurship
development by lowering exit barriers and entry barriers. For entrepreneurs starting up new ?rms, we suggest that they pay
attention to the nuances of bankruptcy laws in their jurisdiction and that if possible they set up ?rms in a jurisdiction that has
entrepreneur-friendly bankruptcy laws.
2. Introduction
Corporate bankruptcies are common. While all entrepreneurs are interested in success, unfortunately a majority of their
ventures fail and many end up in bankruptcy. A challenge confronting policymakers around the world is: How to facilitate more
entrepreneurship development in the face of such odds against entrepreneurial success?
Entrepreneurship is widely seen as one of the most important drivers of economic growth (Schumpeter, 1942). The level of
entrepreneurship in a particular country is not independent of the broader institutional context that has evolved in that country
(Baumol, 1996; North, 1990). Countries that are characterized by institutions that support entrepreneurial activity will, other
things equal, have higher levels of entrepreneurship than countries characterized by institutions that do not support
entrepreneurship (Acs and Laszlo, 2007; Busenitz et al., 2000; Peng et al., 2009; Peng et al., 2008).
Of course, the institutional context of entrepreneurship in a particular country can have many different elements—ranging
from cultural values concerning risk to beliefs about the stigma associated with entrepreneurial failure (Shepherd, 2003;
Yamakawa, 2009). Research has shown that many of these elements are, in fact, related to the rate of entrepreneurship in a
country (Shane, 1996). Because many of these institutional elements re?ect the evolution of values and beliefs in a country over
long periods of time, they are both relatively stable (Hofstede, 2007) and dif?cult to alter with changes in public policy (North,
1990). However, there are some elements of the institutional context of entrepreneurship within a country that are somewhat
more susceptible to policy manipulations. One of these may be a country's bankruptcy laws—a form of formal institutions
(Gamboa-Cavazos and Schneider, 2007).
Indeed, Lee et al. (2007) have argued that a country's corporate bankruptcy laws (hereafter “bankruptcy laws”) can have an
important impact on the level of entrepreneurship in a country.
4
Lee et al. (2007) posit that bankruptcy laws that reduce the cost of
entrepreneurial exit may increase the level of entrepreneurship in a country, while bankruptcy laws that increase the cost of such
exit may reduce the level of entrepreneurship in a country. Peng et al. (2010) show systematic differences in terms of bankruptcy
laws' entrepreneur-friendliness around the world. It follows from this logic that countries seeking to increase the level of
entrepreneurship can, among other things, adjust their bankruptcy laws to reduce the cost of bankruptcy (Armour and Cumming,
2008; Halliday and Carruthers, 2007).
Of course, a country's bankruptcy laws are not independent of other elements of its broader institutional framework, especially
those elements of its culture that are relevant to entrepreneurial activity. Thus, for example, a country that has a culture that is risk
adverse is more likely to have bankruptcy laws that raise the cost of entrepreneurial failure, while a country with a less risk adverse
culture is likely to have bankruptcy laws that impose lower costs of such failures (Lee et al., 2007; Tezuka, 1999). If, as a matter of
public policy, a country is to use changes in its bankruptcy laws to facilitate more entrepreneurship, the impact of those changes on
the propensity of individuals to become entrepreneurs must be greater than those elements in the institutional context that
continue to be anti-entrepreneurial in nature.
In a nutshell, we address two important yet underexplored questions: How do countries' bankruptcy laws affect the level of
entrepreneurship development as measured by the rate of new?rm entry? Do entrepreneur-friendly bankruptcy laws encourage
more entrepreneurship development at a societal level? We endeavor to contribute to theory building and empirical substantiation
with a focus on diverse entrepreneurship phenomena around the world (Zahra, 2007). We begin by more fully developing the logic
that links bankruptcy laws with the level of entrepreneurship in a country. Then we develop hypotheses linking the speci?c
elements of these laws with entrepreneurial behavior and test them with a sample of 29 countries over a 19-year time period.
While our paper builds on the most relevant earlier work by Lee et al. (2007), Peng et al. (2010), and Armour and Cumming
(2008), ours goes beyond these three papers in at least ?ve signi?cant ways. First, Lee et al. (2007) is a theory paper with no
empirical data. Peng et al. (2010) show qualitative data without empirical testing. Ours is the ?rst paper to deepen and broaden
their theoretical ideas, transform them into testable hypotheses, and empirically test them with worldwide data. While Lee et al.
(2007) and Peng et al. (2010) emphasize the bene?t side of bankruptcy and pay less attention to the important component of the
cost of bankruptcy (Bris et al., 2006; Djankov et al., 2008; White, 1984), we have added the estimation of the direct and overall cost
of the bankruptcy proceedings (e.g., cost of petitioning for insolvency, court fees, fees of practitioners, independent assessors,
lawyers, and accountants). The positive externality discussed in Lee et al. (2007) is also complemented by the negative externality
in our research. Second, Armour and Cumming (2008) is an empirical paper that shares the same basic thrust of our paper—with
4
Although a country's personal bankruptcy laws may also affect entrepreneurship development (Armour and Cumming, 2008; Efrat, 2002; Fan and White,
2003; Mankart and Rodano, 2007), we do not deal with personal bankruptcy laws in this article.
506 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
one important difference. Armour and Cumming (2008) deal with the impact of personal bankruptcy laws on entrepreneurship,
and we focus on the impact of corporate bankruptcy laws. Third, Armour and Cumming (2008) cover 15 developed economies
(two in North America and 13 in Western Europe). Our database covers 29 countries that not only include all the countries studied
by Armour and Cumming (2008), but also 14 additional countries in Asia, Latin America, and Oceania—with substantial
representation of emerging economies. Fourth, Armour and Cumming (2008) mainly examine the aspect of bankruptcy
procedures with the direct relationship with creditors using automatic discharge and exemptions from creditors. This is
understandable since they only examine liquidation bankruptcy, while we examine both liquidation and reorganization
bankruptcies. For this reason, we examine the effect of automatic stay of assets and managers' stay on the job, which are
speci?cally related only to reorganization bankruptcy. Fifth and ?nally, we also examine the potential endogeneity problem in the
relationship between bankruptcy law and entrepreneurship development. Following Klapper, Laeven, and Rajan (2006), we use
an instrumental-variable approach and use legal origin as an instrument for fresh start.
3. Entrepreneurship at the societal level
Starting with Schumpeter (1942), there is ample literature on entrepreneurship at the societal level. For example, McGrath
(1999) argues that uncertainty is not always a bad thing even when most entrepreneurs fail if a few successful entrepreneurs can
generate more value to a society than when all entrepreneurs survive, but hardly add value. At a societal level, this logic suggests
that since a society cannot anticipate, with certainty, which entrepreneurial activities will actually generate economic growth and
prosperity, it should encourage the development of a wide variety of such activities (Birley, 1986; Lumpkin and Dess, 1996). From
a societal standpoint, each of these entrepreneurial activities can be regarded as an experiment (McGrath, 1999). Many of these
will turn out to be economically unsustainable, which may lead to numerous bankruptcies—for example, think of numerous e-
commerce failures. However, some of them may turn out to be economically important—think of Google and Yahoo! Without the
bundle of options created by numerous entrepreneurs, a society may not be able to discover those entrepreneurial activities that
actually create economic growth and prosperity (Lee et al., 2007; McGrath, 1999; Nickell, 1996; Peng et al., 2010).
At a societal level, the unlimited upside potential associated with entrepreneurial actions exists because of the potential
economic value that these actions can create. Limiting the downside risks associated with these activities depends on the cost of
failing as entrepreneurs in a society. Failure, although painful for bankrupt entrepreneurs, may be valuable for the society as a
whole (Hoetker and Agarwal, 2007; Knott and Posen, 2005), because it reveals which entrepreneurial endeavors are not likely to
be sources of economic growth.
4. Hypotheses
Following Lee et al. (2007), Peng et al. (2010), and Armour and Cumming (2008), a broad proposition emerges, suggesting
that bankruptcy laws that reduce the cost of entrepreneurial bankruptcy may, other things equal, increase the rate of
entrepreneurship—speci?cally, entry of new ?rms in a country. However, to generate testable hypotheses consistent with this
broad proposition, speci?c dimensions of bankruptcy laws and how they vary across countries must be identi?ed.
Extending Lee et al. (2007) and Peng et al. (2010), we identify ?ve dimensions of bankruptcy laws and develop testable
hypotheses. As shown in Fig. 1, the ?ve dimensions are: (1) the time spent on bankruptcy procedure, (2) the cost of bankruptcy
procedure, (3) the opportunity to have a fresh start in liquidation bankruptcy, (4) the opportunity to have an automatic stay of
assets, and (5) the opportunity for managers to remain on the job after ?ling for bankruptcy.
Fig. 1. Components of bankruptcy laws and entrepreneurship development.
507 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
4.1. Time spent on bankruptcy procedure
The cost of bankruptcy is positively related to the length of time spent on the bankruptcy procedure (Bebchuk, 2000; Bris et al.,
2006). In a liquidation bankruptcy, a fast procedure allows the quick reallocation of assets of failed ?rms to better uses. At the same
time, a fast procedure can provide an entrepreneur a new opportunity to start a new business. By eliminating failing ?rms and
reallocating resources to better uses, a fast bankruptcy procedure may increase variance in a bundle of ?rms at a societal level.
If a ?rm?les reorganization bankruptcy (such as Chapter 11 in the United States), a fast procedure may protect the value of the
assets of the ?rm and improve its chances for an eventually successful turnaround (Bebchuk, 2000). A lengthy process
characterized by an uncertain outcome, however, may make business partners (such as buyers and sellers) reluctant to maintain
their business relationships. This in turn may reduce earnings and the value of ?rm assets (LoPucki and Doherty, 2002). One study
drawing on data from 88 countries ?nds that on average, it takes 2.64 years to resolve, and on average 48% of the ?rm value is lost
during the highly inef?cient bankruptcy process (Djankov et al., 2008). Not surprisingly, managers may become frustrated with
the long procedure, which distracts them from focusing on more important operations. An inef?cient, time-consuming procedure
may end up forcing a ?rm to liquidate by increasing ?nancial distress, while a fast procedure could have saved the ?rm.
In Japan, even when ?nancially insolvent ?rms decide to ?le for bankruptcy, courts will scrutinize the case and decide
whether to allow certain ?rms to declare themselves bankrupt. In other words, some insolvent ?rms are not allowed to
bankrupt. This procedure alone takes more than three months (Alexander, 1999). It is, therefore, not surprising that in Japan, half
of all liquidations took more than three years and more than 75% of reorganizations exceeded ?ve years from application to
conclusion (Alexander, 1999). Obviously, failed entrepreneurs stuck with existing ?rms going through a lengthy bankruptcy
procedure are not in a position to start new ?rms. Overall, a more ef?cient bankruptcy procedure may encourage more entry of
new ?rms—in Silicon Valley, this is known as the motto of “fail fast, fail cheap, and move on.” In Mexico, post-2000 bankruptcy
reforms have shortened the average bankruptcy process from 7.8 to 2.3 years (Gamboa-Cavazos and Schneider, 2007). In
summary:
Hypothesis 1. Less time spent on the bankruptcy procedure will be positively associated with a higher rate of new entry of ?rms
in a country.
4.2. Cost of bankruptcy procedure
In addition to the lengthy time, the actual cost involved in ?ling bankruptcy may also make entrepreneurs procrastinate about
?ling bankruptcy (Bris et al., 2006). One may think that the direct cost of bankruptcy is not very high. However, the World Bank's
Doing Business Report (2008) ?nds that in the United States, the direct cost is approximately 7% of the assets of the ?rm. Bris et al.
(2006) report a higher percentage for U.S. Chapter 11 bankruptcies: 17%. Internationally, Djankov et al. (2008) ?nd bankruptcy
cost amounts to 14% of the estate cost among 88 countries. It costs 22% when ?rms ?le bankruptcy in Italy and Poland, and 36% in
Thailand (Doing Business Report, 2008). This underscores Mason's (2005: 1523) argument that costly bankruptcy “can cause
sluggish economic growth.” In other words, high bankruptcy cost may discourage ?rms to ?le bankruptcies even when at the
societal level, it may be more valuable for them to go bankrupt so that resources and employees can be channeled toward more
productive use. Also, when the cost associated with bankruptcy is high, some entrepreneurs may be discouraged to start
businesses in the ?rst place. Thus:
Hypothesis 2. Less cost spent on the bankruptcy procedure will be positively associated with a higher rate of newentry of ?rms in
a country.
4.3. Fresh start in liquidation bankruptcy
Bankruptcy laws can either discharge bankrupt individuals from debt or allow the pursuit of bankrupt entrepreneurs for years
(OECD, 1998). By discharging bankrupt entrepreneurs, while creditors can claimresidual assets, they cannot pursue any remaining
claims. Since an entrepreneur's future earnings are exempt from the obligations to repay past debt from bankruptcy, this type of
bankruptcy laws are appropriately called “fresh start” laws (Ayotte, 2007; White, 2001). In the absence of a legally protected “fresh
start,” creditors can pursue any remaining claims, at least for some de?ned period of time. In Germany, until the recent bankruptcy
law reforms (Armour and Cumming, 2008), the debtor would remain liable for unpaid debt for up to 30 years (Ziechmann, 1997)
and managers at bankrupt ?rms can be personally liable for criminal penalties (Fialski, 1994). It is not surprising that German
entrepreneurs would have to think twice before starting up new ?rms.
In addition, the 1997–1998 Asian economic crisis revealed that the lack of protection against creditors actually kept many ?rms
from?ling bankruptcy even when it would have made more sense to ?le (Chang, 2006; New York Times, 1998). For executives of
?rms in distress who knowthat the consequences of bankruptcy would hurt thempersonally, ?ling a bankruptcy is likely to be the
last thing they have in mind. This means that many ?rms that should not be alive continue to survive—in essence, “dead men
walking,” a huge opportunity cost to the overall economy (Limand Hahn, 2003). Once these economically unviable ?rms are given
the chance to ?le bankruptcy more easily, some entrepreneurs would be able to start new businesses. Thus:
Hypothesis 3. Discharging bankrupt entrepreneurs more from debt to allowthem to have a “fresh start” will be associated with a
higher rate of new entry of ?rms in a country.
508 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
The ?rst three dimensions we examined above are: (1) time spent on bankruptcy procedure, (2) cost of bankruptcy procedure,
and (3) fresh start in liquidation bankruptcy. We argue that these three dimensions positively affect the rate of newentry because
?rms would be affected by these dimensions regardless of the capabilities of the entrepreneurs. However, the two additional
dimensions, (1) automatic stay of assets in reorganization bankruptcy and (2) the fate of managers, may have different
implications depending on how entrepreneurs are salvaged by the two dimensions, respectively.
Automatic stay of assets is about providing another opportunity to an unfortunate entrepreneur who is capable, but is under
?nancial trouble. For this reason, the automatic stay of assets may extend the economic viability of entrepreneurs and their current
?rms. If the economic viability of entrepreneurs and their current ?rms is extended, they may be less motivated to start new?rms,
thus resulting in a smaller number of new ?rm entries in the next stage. In other words, while nascent entrepreneurs may see
automatic stay of assets as an incentive to start new ?rms, those who are already in business may not come back to restart
businesses once they successfully revive their current ?rms in trouble. It is the same with the fate of managers. Should the
managers stay and revive the ?rms in trouble, they may be less motivated to start new ?rms.
4.4. Automatic stay of assets in reorganization bankruptcy
In some countries, bankruptcy laws may come with an automatic stay of assets and discharge some portion of debt. An
automatic stay upon the start of bankruptcy proceedings means that creditors must cease debt collection efforts and move claims
to the court (Alexopoulos and Domowitz, 1998). The ?rm continues to operate while creditors and ?rms negotiate (Kaiser, 1996).
Before deciding whether the ?rm should be liquidated or not, an automatic stay allows time for managers to communicate with
creditors (Franks et al., 1996). La Porta et al. (1998) ?nd that nearly half of the 49 countries they study do not have an automatic
stay on assets. While automatic stay is allowed in the United States in the case of reorganization bankruptcy (such as Chapter 11),
countries such as Germany, Great Britain, and Japan do not guarantee automatic stay of assets (Alexander, 1999; Hashi, 1997).
In an economy where secured creditors are allowed to repossess their assets when a ?rm?les reorganization bankruptcy, it can
end up in premature liquidations (Broadie et al., 2007). Given uncertainty over the future potential of the ?rm, even when the
value of the ongoing concern is higher than liquidation value, some creditors may have a greater interest in liquidating the ?rm
(Broadie et al., 2007; Wruck, 1990). In Germany, for example, automatic stay does not extend to secured creditors and these
secured creditors have incentives to pursue liquidation bankruptcy (Kaiser, 1996). Therefore, when automatic stay is not in place,
many ?rms do not have the opportunity to ?le a reorganization bankruptcy even when this option is legally allowed. Thus, in turn,
when entrepreneurs knowthat they would not be given a second chance when their ?rms are undergoing dif?culty, some of them
would be discouraged to start new businesses.
While we have not speci?cally examined the downside of lenient bankruptcy laws in the previous three hypotheses, these laws
have costs as well (Lee et al., 2007: 266; see Bebchuk, 2002; Kahl, 2002). Banks may strictly screenpotential entrepreneurs attempting
tosecure ?nancing due to more lenient bankruptcy laws. Inother words, debt forgiveness of failedentrepreneurs may come backwith
an increased cost of ?nancing to potential entrepreneurs, which may become a source of discouragement. Less time and less cost in
bankruptcy procedures can lower the burden of failed entrepreneurs, but at the same time can increase the cost to the banks.
This is not different for the case of fresh start. Fresh start mandates that failed entrepreneurs are exempt from repaying
outstanding obligations (Ayotte, 2007). While residual assets can be claimed, banks cannot pursue for any remaining claims at a
bankruptcy. Since entrepreneurs are exempt fromthe obligations to repay past debts frombankruptcy with future earnings, it can
be very costly to the banks (White, 2001). However, in the absence of a legally protected “fresh start,” creditors can pursue any
remaining claim(Broadie et al., 2007). Maybe this is why past research shows that other than the leniency of the bankruptcy laws,
the level of easy ?nancing is an important factor in new?rm entry (Armour and Cumming, 2008). Not surprisingly Berkowitz and
White (2004) ?nd that in the United States, the rejection rate for ?nancing is over 30% higher in states with unlimited bankruptcy
exemptions compared to states with low exemptions. Thus:
Hypothesis 4a. An automatic stay of assets speci?ed by bankruptcy laws will be positively associated with a higher rate of new
entry of ?rms in a country.
On the other hand, if debt holders in a country have limited ability to secure repayment of their loans to bankrupt ?rms, they
may be forced to increase the cost of ?nancing. In a sense, the increased risk of receiving payment from a bankrupt ?rm for ?rms
operating in countries with automatic stay of assets will be re?ected in the cost of debt capital for these ?rms (Broadie et al., 2007).
This is why past research shows that how easy it is to gain access to ?nancing is an important factor in entrepreneurship devel-
opment (Armour and Cumming, 2008; Mankart and Rodano, 2007). In other words, the opportunity cost of securing loans is the
interest rate that entrepreneurs have to bear (Choi and Phan, 2006; Shane, 1996). A high cost of ?nancing, in turn, may reduce the
number of entrepreneurial entrants in a country.
In addition, if these entrepreneurs are successful in their turnaround attempt, they would be staying with the current ?rms,
which will not necessarily result in the founding of new ?rms. This is why entrepreneurs can often successfully turn around their
?rms in temporary ?nancial trouble in countries where an automatic stay of assets is well protected. For example, in the United
States, Harvard Industries' nick name is Chapter 44 because it ?led reorganization bankruptcy four times (Economist, 2002). Thus,
we suggest a competing hypothesis:
Hypothesis 4b. An automatic stay of assets speci?ed by bankruptcy laws will be positively associated with a lower rate of new
entry of ?rms in a country.
509 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
4.5. The fate of managers
Managers make ?rm-speci?c investments during their tenure with a ?rm. This ?rm-speci?c knowledge would be most
required when a ?rm is in ?nancial distress. The opportunity to stay with the ?rm after ?ling for reorganization bankruptcy
provides incentives for managers to make ?rm-speci?c investments. If managers are going to be driven out when a ?rm ?les
reorganization bankruptcy, they may lack incentives to make ?rm-speci?c investments in the ?rst place (Shleifer and Summers,
1988). If managers know ex ante that they will not be automatically replaced in the case of bankruptcy, however, the opportunity
to stay with the ?rmmay work as a “bonding device” (Gaston, 1997). Thus, when a ?rm?les bankruptcy, providing an opportunity
for managers to stay may provide managers a better chance to revive the ?rm.
Since ?rms are heterogeneous, ?rm-speci?c investments by managers would increase variety and value in a bundle of ?rms
(Barney, 1991). On the other hand, in a manager-replacement systemsuch as a trustee-appointment system, appointing outsiders
without ?rm-speci?c knowledge for reorganization may end up with improper reorganization (Alexander, 1999; Hashi, 1997). For
example, Chapter 11 in the United States allows managers to retain control of the ?rm and provides them the exclusive right to
propose reorganization plans. In contrast, in Great Britain and Germany, control rights are rendered to secured creditors (Franks et
al., 1996). It is not surprising that the practice of allowing secured creditors to take over has been criticized for the reason of
premature liquidation (Kaiser, 1996). Thus, in turn, when entrepreneurs know that they would not be given a second chance to
revive their ?rms under dif?culty, some of them may be discouraged to start new businesses in the ?rst place. On the other hand,
when entrepreneurs are given opportunities to stay on the job and work on the revival of the troubled ?rms, they may be more
willing to take risk and start businesses. Overall:
Hypothesis 5a. Allowing incumbent managers to stay on the job speci?ed by bankruptcy laws rather than forcing out incumbent
managers will be associated with a higher rate of new entry of ?rms in a country.
However, just as making it dif?cult for creditors to secure repayment on their debt can increase the cost of ?nancing and
potentially reduce the level of new ?rm entry in a country, so too can limitations of the ability of outside stakeholders to replace
management increase the cost of capital and other critical resources for entrepreneurial ?rms. Potentially one rationale for
allowing managers to stay with the failing ?rm may be based on an assumption that the factors leading to the ?nancial trouble of
the ?rm are largely exogenous (Daily, 1994; Moulton and Thomas, 1993). However, after all, it is under the care of the incumbent
managers that the ?rm has gone bankrupt. An argument can be made that letting the failed managers stay with the ?rm that is
already in trouble may only give them another opportunity to destroy value. Because managers can take advantage of this special
treatment of letting them stay during times of dif?culty, some scholars call this type of move as a “strategic bankruptcy (Moulton
and Thomas, 1993). Thus, letting failed managers stay in their positions when a ?rmis in ?nancial distress may increase the cost of
capital. This, in turn, can also have a negative impact on the rate at which entrepreneurship emerges in a country.
In addition, as argued above, if entrepreneurs are more likely to turn around their ?rms, they would stay with the ?rm rather
than starting new businesses. For this reason, it is quite possible that letting managers stay with the ?rm at the time of
reorganization bankruptcy may dampen the new entry of ?rms. Speci?cally:
Hypothesis 5b. Allowing incumbent managers to stay on the job speci?ed by bankruptcy laws rather than forcing out incumbent
managers will be associated with a lower rate of new entry of ?rms in a country.
In summary, Hypotheses 1, 2, and 3 suggest an unambiguous relationship between entrepreneur-friendly bankruptcy laws and
the rate of entrepreneurship in a country as measured by the entry of new ?rms. These hypotheses focus directly on the cost of ?ling
for bankruptcy—minimizing such cost is economically ef?cient for all of a ?rm's stakeholders (Lee et al., 2007; Peng et al., 2010).
Hypotheses 4a–4b and 5a–5b suggest contradictory relationships between bankruptcy laws and the entry of new?rms into a country.
This is because these two sets of hypotheses focus on howthe problems that would lead a ?rmto declare bankruptcy are resolved. If the
process by which these problems are resolved favors managers (as in Hypotheses 4a and 5a), then that may give individuals more
incentives to become entrepreneurs. On the other hand, those incentives may be counter-balanced by the increased costs that
entrepreneurs would have to bear to compensate other stakeholders for the increased risks they would have to bear, in the face of
bankruptcy(Bebchuk, 2002; Broadieet al., 2007; Kahl, 2002). Theseincreasedcosts mayreducethelevel of new?rmentries inacountry.
The net effect of Hypotheses 4a versus 4b and of Hypotheses 5a versus 5b, on the entry of new?rms into a country's economy,
is ultimately an empirical question (Bebchuk, 2002: 457). However, if the size of these contradictory effects is approximately
equal, these relationships may cancel each other and result in non-signi?cant ?ndings.
5. Methods
5.1. Data
We have collected data for 29 countries during a 19-year period (1990–2008, inclusive). Our sources include past studies on
commercial bankruptcy ?lings collected from government and private sources (Claessens and Klapper, 2005),
5
on the legal rules
covering protection of corporate shareholders and creditors, their origin, and the quality of their enforcement (La Porta et al.,
5
We thank Stijin Claessens and Leora Klapper for sharing part of their data for our research.
510 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
1998), and on the regulation of entry (Djankov et al., 2002). We have also collected additional data fromsources such as the World
Bank,
6
the Organization for Economic Co-operation and Development (OECD), the World Health Organization (WHO), and the
International Monetary Fund (IMF). Table 1 outlines our data across the 29 countries.
It is natural for the bankruptcy variables to correlate with each other. But, according to the correlation table, there are some
exceptions. For example, the correlations between the closing time and the automatic stay of assets and the closing time and the
stay of incumbent management are not signi?cant. This is probably because while closing cost and closing time are part of the
overall administrative costs decided at the court and related to liquidation bankruptcy, automatic stay of assets and stay of
incumbent management are decided by the legislature and associated with liquidation bankruptcy. We also observe that not all
the bankruptcy variables are positively correlated. This suggests that many countries may have developed bankruptcy laws in a
piece-meal manner (De Soto, 2003).
5.2. Dependent variable
In our hypotheses, we predict how various components of the bankruptcy laws can curtail the downside risk of entrepreneurs
and help encourage risk-taking behavior such as new ?rm entry. The dependent variable in our model is thus the rate of new ?rm
entry (Kawai and Urata, 2002; Klapper et al., 2006; Yamawaki, 1991). We use OECDdata on the ratio of the number of new?rms to
the total number of ?rms (previous year) in a country.
7
5.3. Independent variables
5.3.1. Closing time
The data are obtained from the World Bank (Djankov et al., 2008). Closing time refers to the average time (in years) to
complete a bankruptcy procedure within a country. Since we argue that a shorter time for bankruptcy procedure is associated with
a higher rate of bankruptcy ?ling, we reverse the signs of the lengths of time from positive to negative.
6
Doing Business Report, International Finance Corporation, The World Bank Group (http://www.ifc.org).
7
For certain instances, the OECD did not provide the rate of new ?rm entry but provided data on the number of ?rms in total in a particular year end (T
t
) and
the number of ?rms that ?led bankruptcy in a particular year end (D
t
). In these cases, we calculated the number of entries (B
t
) by T
t
=B
t
+T
t ?1
?D
t
so that
B
t
=T
t
?(T
t ?1
?D
t
), whereas the rate of new ?rm entry BR
t
=B
t
/ T
t ?1
.
Table 1
New ?rm entry rates (the ratio of new ?rms to the total number of ?rms) and bankruptcy law differences.
Sources: Claessens and Klapper, 2005; Doing Business Report, World Bank; La Porta et al., 1998; OECD data.
Country New ?rm entry
rate
a
Time (years) spent
on bankruptcy
a
Cost (% of estate)
of bankruptcy
a
Fresh start
(recovery rate:
cents/$)
a
Automatic stay of
assets (1: stay;
0: no stay)
Stay of incumbent
management
(1: stay; 0: no stay)
Argentina 0.07 2.8 14.6 75.9 1 1
Australia 0.11 1.0 8.0 19.9 1 1
Austria 0.08 1.1 18.0 26.9 0 1
Belgium 0.07 0.9 4.0 13.9 0 1
Canada 0.10 0.8 4.0 10.4 1 1
Chile 0.07 5.5 17.5 79.8 1 1
Denmark 0.10 3.2 4.0 35.0 0 1
Finland 0.08 0.9 4.0 11.6 1 1
France 0.08 1.9 9.0 53.9 1 1
Germany 0.17 1.2 2.2 44.2 0 1
Greece 0.06 2.0 9.0 55.3 1 0
Hong Kong 0.04 1.1 9.0 19.1 0 0
Ireland 0.05 0.4 9.0 12.3 1 1
Italy 0.08 1.3 18.7 52.4 1 1
Japan 0.04 0.6 4.0 7.4 1 0
Netherlands 0.09 1.1 4.0 12.5 1 1
New Zealand 0.20 1.3 4.0 21.2 0 0
Norway 0.11 0.9 1.0 6.5 1 1
Peru 0.11 3.1 7.0 69.8 1 1
Portugal 0.09 2.0 9.0 26.6 1 1
Singapore 0.18 0.8 1.0 8.7 0 0
South Korea 0.03 1.5 4.0 18.9 0 0
Spain 0.10 1.0 15.0 22.6 0 1
Sweden 0.07 2.0 9.0 28.3 1 1
Switzerland 0.02 3.0 4.0 53.5 1 1
Thailand 0.09 2.7 36.0 59.4 0 0
Turkey 0.04 3.3 15.0 88.3 1 1
United Kingdom 0.13 1.0 6.0 14.7 0 0
United States 0.10 1.5 7.0 20.1 1 1
a
Average during 1990–2008.
511 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
5.3.2. Closing cost
Similarly, we use data provided by the World Bank to measure the cost associated with bankruptcy ?lings (Djankov et al.,
2008). Closing cost represents the cost of the bankruptcy proceedings (% of estate). Again, to align with our argument that a lower
cost of bankruptcy is associated with a higher ?ling rate, we reverse the signs from positive to negative.
5.3.3. Fresh start
We use the rate of recovery froma closing to measure the degree of an entrepreneur's fresh start as speci?ed by the bankruptcy
laws. Since the likelihood of pursuits of remaining claims is associated with closing recovery, we use this variable to proxy for an
entrepreneur's fresh start. Closing recovery exhibits the recovery rate, which calculates how many cents on the dollar claimants
such as creditors, tax authorities, and employees recover froman insolvent ?rm. We assume that the greater the claimants recover
from an insolvent ?rm, the less is recovered by entrepreneurs themselves, thereby the less likely they will have a fresh start. In
order to align with our argument that lower recovery by others is associated with higher ?ling rate, we calculate fresh start as one
dollar (100 cents) minus the rate of recovery as cents per dollar by others such as creditors, tax authorities, and employees. Data
for this variable are also obtained from the World Bank.
5.3.4. Automatic stay of assets
We use data originally collected by La Porta et al. (1998) and frequently used in subsequent research (Claessens and Klapper,
2005; Peng et al., 2010; Pistor, 2000). This variable represents one of the dummy variables created in La Porta et al. (1998),
whether or not the reorganization procedure imposes an automatic stay on the assets, thereby preventing secured creditors from
getting possession of loan collateral. Whereas La Porta et al. (1998) de?ne it “no automatic stay on secured assets,” here, we label it
reversely as “automatic stay of assets.” Accordingly, this variable equals to 1 if there is automatic stay of assets; and 0 otherwise
that such a restriction does not exist in the law.
5.3.5. Stay of incumbent management
This variable also refers to one of the dummy variables that constitute La Porta et al.'s (1998) index of creditor rights. La Porta et
al. (1998) label this as “management does not stay,” which we label here reversely as “stay of incumbent management.”
Accordingly, the variable equals to 1 if incumbent management stays during a restructuring or bankruptcy; and 0 otherwise (i.e.,
when an of?cial appointed by the court, or by the creditors, is responsible for the operation of the business during reorganization,
or when the debtor does not keep the administration of its property pending the resolution of the process).
5.4. Control variables
We control for six sets of factors. First, we expect that economic performance of a country would affect its rate of new?rmentry
(Shane, 1996). Countries experiencing positive growth may have higher rates of new?rmentry (Kawai and Urata, 2002). Thus, we
control for countries' general level of development and macroeconomic performance. For general development, we include lagged
real GDP per capita in US dollars. For macroeconomic performance, we include the growth rate of real GDP lagged one year
obtained fromthe IMF (Claessens andKlapper, 2005). In addition, we control for the interest rate as well as the number of banks per
capita withina country ina givenyear inorder to capture the variance and stability of a country's ?nancing infrastructure (Bandiera
et al., 2000; Caprio and Honohan, 1999; Goderis and Ioannidou, 2008).
Second, in our attempt to control for unobserved regional effects, we create dummy variables for regions (e.g., Europe, Asia)
with North America as the reference category. Differences in national institutions can bring about different levels of
entrepreneurial activity across countries (Baumol, 1996; Busenitz et al., 2000; North, 1990). We control for regions to account
for these differences explained by a broader set of institutions that guides and constrains entrepreneurial behavior. We also
control for general institutional quality that may in?uence new?rm entry rates in other forms than bankruptcy, such as ef?ciency
of law. We account for this by controlling for the “rule of law”—an assessment of the law and order tradition within a country
(Claessens and Klapper, 2005; La Porta et al., 1997, 1998).
Third, we control for time effects across all countries (Caprio and Klingebiel, 2002). We include a variable measuring
years elapsed from 1990 to capture any time trend effects associated with changes in the bankruptcy rate (Rhee and Haunschild,
2006).
Fourth, we control for differences in the informal aspects of the institutional environment, such as “uncertainty avoidance,”
obtained from Hofstede (2001). In other words, the same entrepreneur-friendly bankruptcy laws may have different implications
for entrepreneurs in different institutional environments (Lee et al., 2007; Sutton and Callahan, 1987).
Fifth, we control for the of?cial cost of all procedures required to register a ?rm expressed as percentage of gross national
income [GNI] per capita, using World Bank data. Finally, since the rate of exit (previous year) and the rate of new entry (the
following year) may be positively correlated, we control for bankruptcy rate (previous year).
5.5. Model speci?cation
We model the rate of new ?rm entry using the following power function:
ER
i; t
= BR
a
it?1
exp ?CT
it?1
+ ?CC
it?1
+ ?RR
it?1
+ ?SA
it?1
+ iMS
it?1
+ ?C
it?1
ð Þ? ðIÞ
512 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
where
ER
i, t
the rate of new ?rm entry in a given country i at a given year t
BR
it ?1
the bankruptcy rate in a given country i at a given year t ?1
CT
it ?1
the average closing time (in years) to complete a bankruptcy procedure in country i during year t ?1
CC
it ?1
the average closing cost (% of estate) of the bankruptcy proceedings in country i during year t ?1
RR
it ?1
the recovery rate (cents on the dollar) of bankruptcy ?lings in country i during year t ?1
SA
it ?1
a dummy variable indicating whether the reorganization procedure allows an automatic stay of assets (1) or otherwise
(0) in country i during year t ?1
MS
it ?1
a dummy variable indicating whether the incumbent management is allowed to stay (1) or otherwise (0) in country i
during year t ?1
C
it ?1
a vector of control variables (described below) in country i during year t ?1
? a log normally distributed error term.
By transforming Eq. (I) to its natural logarithm, we obtain the linear equation with a normally distributed error term, ?:
Log ER
i;t
= ?log BR
it?1
ð Þ + ?CT
it?1
+ ?CC
it?1
+ ?RR
it?1
+ ?SA
it?1
+ i MS
it?1
+ ?C
it?1
+ ? ðIIÞ
We use a logarithm transformation to allow our dependent variable (percentage) to take both positive and negative values
rather than being constrained to be positive. This log-linear model is commonly used in econometric estimation for percentage
changes, and is more consistent with the assumption of normally distributed error terms (Greene, 2000).
5.6. Estimation
We estimate the parameters of Eq. (II) on unbalanced, pooled, cross-national, time-series data with yearly time periods. Since
we do not have the same number of years for which we have observations on bankruptcy rates for each country, the number of
observations varies among countries. Due to missing data, we have a total of 229 country-year observations.
8
In order to take into account both inter- and intra-variations among country observations, we use the generalized estimating
equations (GEE) to test our hypotheses (Liang and Zeger, 1986; Rhee and Haunschild, 2006). Since our dataset contains multiple
and unbalanced observations for each country, we use this estimation technique as a superior approach than a standard Ordinary
Least Squares (OLS)-based regression models. Because observations for countries are organized into a pooled cross-sectional time-
series dataset, there will be potential for non-independence and cross-sectional heteroskedasticity. Thus, OLS-based estimates
could produce correlated error terms, under-stated standard errors, and in?ated t-statistics (Holcomb et al., 2009). Speci?cally, we
use the identity link, the Gaussian distribution, and the exchangeable option of the correlation matrix in order to correct for the
correlation from repeated observations made for each country (Rhee and Haunschild, 2006). Furthermore, we also use the cluster
command in STATA to obtain a robust variance estimate that accounts for (and adjusts for) within-country correlation and within-
group dependence (Barkema and Shvyrkov, 2007; Williams, 2000).
5.7. Marginal effects
In order to assess the economic signi?cance, we examine the marginal effects of independent variables on the dependent
variable. Economic signi?cance of marginal effects depends on the magnitude of change in the independent variables. However,
since coef?cient estimates are dif?cult to interpret (Greene, 2000), we use the mfx command in STATA to obtain the elasticities of
the form dy/ dx at the desired values of independent variables to calculate the marginal effects of independent variables
(Nickerson and Silverman, 2003).
6. Findings
Table 2 presents descriptive statistics. In order to capture any possible multicollinearity problems associated with high
correlation, we ?rst check all variance-in?ation factors (VIFs), tolerance, and condition indexes. While individual VIFs greater than
10, the average VIF greater than 6, and the individual tolerance less than 0.1 are generally seen as indicative of severe
multicollinearity, the maximum VIF of our data is 5.32, the mean VIF is 2.40, and none of the tolerance is less than 0.1, suggesting
little problem of multicollinearity.
Table 3 presents the GEE estimates on the changes in the rate of new?rmentry derived fromEq. (II). Model 1 is the base model
containing only the control variables. Models 2 to 6 represent the main effect of each of our independent variables. Model 7 is our
?nal model containing all key variables.
8
For example, STATA dropped observations due to missing number of banks. The main cause, however, was due to the lack of data availability on the rate of
new ?rm entry among country-year observations (i.e., we start with 551 possible observations from a 19-year-and-29-country panel, and end up with 229
observations for valid analysis).
513 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
Table 2
Descriptive statistics and Pearson correlation coef?cients — 29 countries, 1990–2008.
Source: Variable 1 (OECD Data); Variables 2–4 (World Development Indicators); Variables 5, 11 (Claessens and Klapper, 2005); Variables 7, 15, 16 (La Porta et al., 1998); Variable 9 (Hofstede, 2001); Variables 10, 12–14
(Doing Business Report, World Bank).
Variable Mean S.D. Min. Max. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
1. Log [new ?rm
entry rate]
?2.47 .50 ?4.30 ?1.41
2. Log [GDP/capita
(t ?1)]
9.47 .93 7.19 10.94 ?.03
3. GDP growth
(t ?1)
3.34 3.22 ?12.57 12.82 ?.00 ?.10 **
4. Interest rate
(t ?1)
6.42 7.13 ?18.95 72.26 .06 ?.32 *** ?.24***
5. Log [number of
banks/capita]
?4.81 1.61 ?8.19 ?.34 .12* .31 *** .04 ?.04
6. Asia .17 .37 0 1 ?.33*** ?.07 * .19*** ?.05 ?.11***
7. Europe .59 .49 0 1 .03 .32 *** ?.21*** ?.13 *** .21*** ?.54 ***
8. Rule of law
(judicial
ef?ciency)
8.11 2.19 2.08 10 .25*** .80 *** ?.16*** ?.32 *** .24*** ?.19 *** .43 ***
9. Years since
1990
9.71 5.31 0 18 .35*** .10 *** .10* ?.19 *** .07* ?.00 ?.01 ?.04
10. Uncertainty
avoidance
63.09 26.13 8 112 ?.22*** ?.23 *** ?.05 .09 ** ?.05 ?.05 .01 ?.24*** ?.02
11. Log [start-up
cost (t ?1)]
1.74 1.34 ?2.30 3.70 .19*** ?.58 *** .01 .28 *** ?.08* .02 ?.04 ?.61*** ?.03 .50 ***
12. Log
[bankruptcy
rate (t ?1)]
?.19 1.52 ?5.19 2.45 .24*** .41 *** ?.13*** ?.22 *** .17*** ?.17 *** .13 *** .48*** .07 * ?.54 *** ?.48 ***
13. Closing time ?2.36 2.33 ?9.5 ?.1 .53*** .22 *** .02 ?.04 .02 ?.09 ** .06 .17*** ?.01 ?.03 ?.12 *** .07*
14. Closing cost ?12.93 11.89 ?45 ?1 .62*** .30 *** ?.07* .04 ?.04 ?.40 *** .16 *** .25*** .01 ?.22 *** ?.27 *** .17*** .51 ***
15. Fresh start 38.48 24.70 5.6 99.6 .39*** ?.64 *** .07* .21 *** .04 ?.16 *** ?.12 *** ?.46*** .04 .14 *** .31 *** ?.15*** ?.32 *** ?.16***
16. Automatic stay
of assets
.65 .48 0 1 ?.20*** ?.06 ?.08** ?.00 ?.00 ?.32 *** ?.02 ?.06 ?.01 .26 *** .28 *** .13*** ?.11 *** .03 .11 ***
17. Stay of
incumbent
mgmt
.70 .46 0 1 .08 .15 *** ?.13*** .01 .16*** ?.57 *** .36 *** .28*** ?.02 .17 *** .09 * .13*** ?.05 .10*** ?.07 * .46***
Note: t denotes current year.
*
pb0.10.
**
pb0.05.
***
pb0.01.
5
1
4
S
.
-
H
.
L
e
e
e
t
a
l
.
/
J
o
u
r
n
a
l
o
f
B
u
s
i
n
e
s
s
V
e
n
t
u
r
i
n
g
2
6
(
2
0
1
1
)
5
0
5
–
5
2
0
The effect of closing time and closing cost exhibit positive and signi?cant (pb.01) results, therefore supporting both
Hypotheses 1 and 2. In other words, the less time and less costs associated with bankruptcy proceeding are associated with a
higher rate of new ?rm entry in the next year (there is a one-year lag in all models). The signi?cant (pb.05) and positive effect of
fresh start also provides support for Hypothesis 3. The result shows that the more entrepreneurs recover from bankruptcy (which
would mean a fresher start), the higher the rate of new?rm entry in a country. Furthermore, the signi?cant (pb.05) and negative
effect of automatic stay of assets supports Hypothesis 4b but not 4a. The result indicates that allowing assets to stay is not
associated with a higher rate of new ?rm entry; rather, it works the other way around. Finally, neither Hypotheses 5a nor 5b are
supported.
Table 4 presents the marginal effects of our main variables. The results show the magnitude of the effects of independent
variables on the dependent variable—computed in terms of a unit change in the dependent variable associated with a change in
one standard deviation in each independent variable from the mean shown in Table 2. When it comes to a dummy variable, it is a
change fromzero to one. The results indicate that 0.03 year (approximately 10 days) spent on closing time compared to 2.36 years
(approximately 29 months) is associated with a 10% increase in the likelihood of a new ?rm entry. The difference between 1.04%
and 12.93% of estate spent on closing cost translates into an 11% higher likelihood of new?rmentry as well. When it comes to fresh
start, securing 63.18% of the assets means an 11% higher likelihood of new?rmentry compared to when an entrepreneur can only
secure 38.48% of the assets. Finally, when automatic stay of assets is guaranteed, there is an 8% decrease in the likelihood of a new
?rm entry.
In terms of robustness checks, we have tested various additional models (e.g., unconditional speci?cation without the controls,
with only the most basic controls) as well as incorporated various other variables in addition to the main control variables. In order
to correct for unobserved period effects or convergence forces such as large positive shock in ?rm entry, we have included year
dummies for the 19 years. To account for the social dimension of bankruptcy laws, we have controlled for the level of social stigma
Table 3
GEE estimates of new ?rm entry rate — 29 countries, 1990–2008.
Variable Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Hypothesis testing
Log [GDP/capita (t ?1)] ?.000 ** ?.000*** ?.000*** ?.000* ?.000 ** ?.000*** ?.000***
(.000) (.000) (.000) (.000) (.000) (.000) (.000)
GDP growth (t ?1) .007 .005 .006 .007 .008 .008 .003
(.005) (.005) (.005) (.005) (.006) (.005) (.005)
Interest rate (t ?1) ?.004 ?.006 ?.003 ?.004 ?.004 ?.004 ?.007
(.005) (.005) (.004) (.005) (.005) (.005) (.004)
Log [number of banks/capita] .001*** .001*** .002*** .001** .001** .001*** .001***
(.000) (.000) (.000) (.000) (.000) (.000) (.000)
Asia ?.589 ** ?.468** ?.096 ?.501** ?.797 *** ?.727*** .010
(.241) (.186) (.168) (.240) (.227) (.250) (.190)
Europe ?.294 ** ?.238* ?.137 ?.257** ?.383 *** ?.298** ?.168
(.142) (.133) (.125) (.130) (.105) (.126) (.107)
Rule of law (judicial ef?ciency) .107** .081* .057 .124*** .087** .109*** .049
(.043) (.049) (.044) (.047) (.042) (.039) (.048)
Years since 1990 .008 .008 .015** .008 .006 .009 .008
(.008) (.007) (.007) (.009) (.008) (.008) (.007)
Uncertainty Avoidance ?.003 ?.005* ?.002 ?.003 ?.003 ?.003 ?.002
(.003) (.003) (.002) (.003) (.003) (.003) (.003)
Log [start-up cost (t ?1)] .007 .003 .003 .008* .010** .008* .005*
(.005) (.004) (.005) (.004) (.004) (.005) (.003)
Log [bankruptcy rate (t ?1)] ?.025 ?.023 .002 ?.035 .037 ?.018 .022
(.036) (.030) (.040) (.038) (.035) (.038) (.038)
Closing time .081*** .051** Hypothesis 1 supported
(.022) (.022)
Closing cost .031*** .024*** Hypothesis 2 supported
(.003) (.004)
Fresh start .004** .005** Hypothesis 3 supported
(.002) (.002)
Automatic stay of assets ?.410 *** ?.308** Hypothesis 4b supported
(.127) (.123)
Stay of incumbent mgmt .206 .203 Hypotheses 5a and 5b
not supported
(.186) (.162)
Constant ?2.830*** ?2.198 *** ?2.055 *** ?3.205 *** ?2.395*** ?2.686 *** ?2.292 ***
Wald Chi-squared 71.01*** 78.98*** 304.38*** 95.32 *** 57.47*** 79.54*** 397.44***
Marginal R-squared .266 .515 .663 .306 .351 .285 .732
D.f. 11 12 12 12 12 12 16
N 229 229 229 229 229 229 229
Note. Semi-robust standard errors in parentheses; t denotes current year.
*
pb0.10.
**
pb0.01.
***
pb0.10.
515 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
concerning failure by incorporating the suicide rate (by year, per 100,000 populations) obtained fromthe WHO.
9
We have also tested
the number of days and the number of procedures to start a business obtained from the Doing Business Report (World Bank). Since
personal bankruptcy laws may apply more to smaller ?rms and that the distribution of ?rm size may affect the occurrence of
bankruptcies, following Claessens and Klapper (2005), we also use the percentage of employment attributed to small- and medium-
sized enterprises (SMEs) as a control. Furthermore, we have also tried the rate of new ?rm entry in the previous year as a control
variable to see if the previous level of new?rmentry affects the rate of new?rmentry in a given year. Finally, in order to account for
measurement error in our dependent variable, we have created the average new?rmentry rate over the time period and tested our
hypotheses (Armington and Acs, 2002). The results are not qualitatively different from our main ?ndings.
10
Another robustness check that we have added is an attempt to tease out the possibility of reverse causality. We utilize an
instrumental-variable approach (Klapper et al., 2006; Kwok and Tadesse, 2006) and test several variables as an instrumental
variable. Among the bankruptcy law variables, Fan and White (2003) argue that fresh start is the most important variable for
entrepreneurs since its impact can be enormous. We also ?nd that among the ?ve bankruptcy variables, fresh start is the only
variable that has a signi?cant relationship with interest rate and the relationship is positive. This shows that fresh start may be the
most important variable when it comes to debt forgiveness. For this reason, following Klapper et al. (2006), we use legal origin as
an instrument for fresh start. In the ?nance and economics literature, using such an institutional variable is customary (Kwok and
Tadesse, 2006). Speci?cally, we use the ivreg command and robust option in STATA to obtain a robust estimate. We ?nd the results
are qualitatively similar to the original results we have obtained.
7. Discussion
7.1. Contributions
Overall, at least three contributions emerge. First, this paper leverages insights from the past literature to address an
entrepreneurship issue that has important public policy implications (Acs and Laszlo, 2007; Cumming et al., 2009; Shade and
Siegel, 2008).
11
In general, we ?nd that the less the downside risk involved in ?ling bankruptcy, the more new?rms are founded.
For policymakers, we suggest that making bankruptcy laws more entrepreneur-friendly will positively affect entrepreneurship
development by lowering exit barriers and entry barriers. For entrepreneurs starting up new ?rms, our advice is that they pay
attention to the nuances of bankruptcy laws in their jurisdiction and that if possible they set up ?rms in a jurisdiction that has
entrepreneur-friendly bankruptcy laws. Although management and entrepreneurship research rarely engages in public policy
issues (as critiqued by Barney, 2005; Kochan et al., 2009; and Peng et al., 2009), the public policy implications of our research are
clear. Speci?cally, our research draws on and extends the recent advance of an institution-based view of entrepreneurship in the
literature (Peng et al., 2008, 2009, 2010) by shedding considerable light on how speci?c formal institutions–in this case,
bankruptcy laws–matter and thus by contributing to important public policy debates.
Second, we extend the arguments made by Lee et al. (2007) and Peng et al. (2010) that at a societal level, entrepreneur-friendly
bankruptcy laws can lower entry barriers by encouraging entrepreneurs to take more risks and start-up more new ?rms. When
risk-taking is encouraged by more entrepreneur-friendly bankruptcy laws, it can generate a variety of entrepreneurial options at
a societal level by increasing the number of ?rms with high growth potential in a country. This may lead to more entrepreneur-
ship and economic development at a societal level. Thus, we echo Hoetker and Agarwal (2007), Knott and Posen (2005),
McGrath (1999), Lee et al. (2007), and Peng et al. (2010) by arguing that failure, although painful for individual entrepreneurs,
may be good—for the economy.
9
For example, in Japan, where stigma of failure is very high, it is well-known that bankrupt entrepreneurs often commit suicide (Time, 1999). About 30 people
commit suicide per day for economic reasons in Japan (Takahashi, 2003).
10
Results are not shown here but are available upon request.
11
This point is underscored by the fact that an earlier version of this article received the U.S. Small Business Administration Best Paper Award for a Babson
Conference paper “exploring the importance of small businesses to the U.S. economy and public policy issues of importance to the entrepreneurial community”
at the 2008 Babson Conference.
Table 4
Signi?cant marginal effects of variables on the rate of new ?rm entry.
Variables Estimated marginal effect
Control variables
GDP per capita ?.087
Number of banks per capita .100
Start-up cost .100
Main variables
Closing time ( Hypothesis 1) .100
Closing cost ( Hypothesis 2) .113
Fresh start ( Hypothesis 3) .113
Automatic stay of assets ( Hypothesis 4b) ?.084
516 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
Third, we empirically substantiate our argument through a longitudinal, cross-country database covering 29 countries on ?ve
continents and spanning 19 years. Our ?ndings, based on corporate bankruptcy laws, converge with those reported by Armour and
Cumming (2008), who focus on personal bankruptcy laws in 15 countries on two continents. Speci?cally, we ?nd that the less time
and less cost associated with the bankruptcy procedure encourages more new ?rm entries. For example, on average ?rms spend
approximately 29 months going through the bankruptcy proceedings. Decreasing this agonizing period to 10 days can boost the
likelihood of new ?rm entry by 10%. It is the same with the cost of bankruptcy. When less can be spent in the bankruptcy
proceeding, this means increased new?rmentry as well. We also ?nd that providing a failed entrepreneur with a fresher start will
encourage higher likelihood of new entry.
It is puzzling that allowing an automatic stay of assets actually dampens the entry of new ?rms. Also, enabling managers to
keep their positions in bankrupt ?rms does not necessarily have a signi?cant impact on new?rm entry. Our ?ndings suggest that
there may be important adverse selection issues associated with keeping a failing ?rm's managers in place—the managers who are
associated with an entrepreneurial ?rm's ?nancial distress may not always be the best managers to continue to manage a ?rm
(Bebchuk, 2002).
The signi?cant results of some of our control variables are noteworthy. We ?nd that the degree of a country's previous economic
development such as GDP per capita, ?nancing infrastructure such as the number of banks per capita, as well as ?nancial barrier to
entry such as start-up cost indeed affect the rate of new ?rm entry within a country (Table 3). The marginal effects of the control
variables (Table 4) showthe magnitude of their effect onnew?rmentry rate. Interms of GDPper capita, a difference of approximately
$12,000 translates to an 8% likelihood of new ?rm entry. The establishment of approximately 1.3 banks (per 1 million population)
means 10% more new ?rm entry likelihood than 0.3 banks (per 1 million population). When it comes to start-up cost, a difference
between a 10.43% and 20.65% of GNI per capita to register a ?rm translates into a 10% change in new ?rm entry likelihood.
Finally, it is important to highlight the similarities in the letter and spirit of personal and corporate bankruptcy laws, although
as noted earlier in this article we choose not to deal with personal bankruptcy laws. For example, the concepts of “fresh start” and
“automatic stay” in corporate bankruptcy laws are similar to “discharge” and “exemptions,” respectively, in personal bankruptcy
laws (Armour and Cumming, 2008). However, many entrepreneurs choose to incorporate their ?rms in order to protect their
personal assets, in case their ?rms go under. Therefore, our ?ndings, from a corporate bankruptcy law perspective, complement
and strengthen Armour and Cumming's (2008) ?ndings that originate from a personal bankruptcy law perspective. In other
words, our study starts to ?ll an important missing gap in the previous literature in terms of how entrepreneur-friendly corporate
bankruptcy laws facilitate more entrepreneurship at a societal level.
7.2. Limitations and future research
Among limitations, our analysis does not incorporate time-varying bankruptcy variables. In other words, we are not able to
account for the changes in corporate bankruptcy laws during the time period in the countries that are covered. While we can take
account of measures such as origin of law and rule of law (La Porta et al., 1997), we are unable to capture the various levels of
development of bankruptcy laws among the countries over time. This is an important limitation that future research may need to
overcome.
Since the Doing Business Report (World Bank) is not a direct measure of outcomes and is, instead, derived from surveys
administered through local experts (e.g., lawyers, consultants, and of?cials), one may also question the consistency of results
across countries. However, the survey is designed with academic advisors, routinely administered through more than 6000 local
experts, and subject to numerous tests for robustness. Data are collected in a highly standardized way to ensure comparability
across economies and over time. This methodology actually offers several advantages including its transparency, allowing multiple
interactions with local respondents to clarify potential misinterpretations of questions.
In a broader sense, we have examined mainly the regulatory, thereby formal, aspects of the institutional environment and their
effect on new ?rm entry. While we have used an important informal aspect of the institutional environment as a control variable
(uncertainty avoidance), it may be interesting to explore the interaction and/or moderating effects of this and other informal
aspects of a country's institutional environment (Peng et al., 2008, 2009). In the case of default, informal workouts are often
undertaken instead of formal insolvency proceedings. In future work, it will be important to examine how formal and informal
constraints can be integrated to create a more coherent understanding of how institutions constrain or facilitate entrepreneurial
activities in different countries.
Also, as suggested in Kaufmann et al. (2007) and Lee et al. (2007), many entrepreneurs may not investigate the nuances of
bankruptcy laws before starting up new businesses. Thus, the ex ante effects of bankruptcy laws on entrepreneurial entry may not
be as strong as suggested by our theory. However, if this is the case, then the results presented here are quite conservative in
nature. Past research on U.S. ?rms, however, shows that there is a signi?cant difference in new?rm formation depending on how
lenient the bankruptcy laws are in different states (Fan and White, 2003). Nevertheless, since similar cross-regional studies within
the same country have not been done on countries other than the United States, where institutions are well developed, it is
worthwhile to examine the relationship in other countries (Davidsson and Wiklund, 1995). It is possible that when other
institutions are more developed, entrepreneurs may become more sensitive to bankruptcy laws. On the other hand,
underdevelopment of other essential institutions such as ?nancing and legal protection of properties may make entrepreneurs
pay less attention to bankruptcy laws, which may have a limited impact.
For example, when property rights are not well protected, entrepreneurs may not pay enough attention to the terminal stage of
bankruptcy. Just making sure that property rights are protected would be already an overwhelming task for many countries. This
517 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
may be the reality in many emerging and developing economies, but the United States was not much different in the early 1800s.
For example, “the Chief Justice of the Supreme Court, Joseph Story, wondered in 1820, whether lawyers would even be able to
settle them [bankruptcies and other property rights disputes]” (De Soto, 2003: 9). Clearly, tremendous entrepreneurial and
economic development in the United States since the early 1800s is not entirely due to certain entrepreneur-friendly bankruptcy
laws. Such bankruptcy laws function in the much larger institutional framework facilitating entrepreneurial and economic
development (North, 1990). Likewise, reforming bankruptcy laws and making them more entrepreneur-friendly should not be
viewed as panacea for countries interested in promoting entrepreneurship development. It is the overall balanced development of
the institutions that spurs entrepreneurship, not a piece-meal type development of certain aspects of institutions.
Furthermore, more systematic research in this area such as emerging economies (EE) versus developed economies (DE), high-
tech versus low-tech industries, small entrepreneurial versus large incumbent ?rms may be worthy of exploration. For example,
while some of our attempts did not achieve convergence due to the limited sample size when it comes to splitting data between EE
and DE (Wright et al., 2005), it would be interesting to see the differential effects on ?rms in DE versus EE (Yamakawa et al., 2008).
In terms of industry variation, a high-tech industry characterized by high uncertainty and high variance may be associated with
lower levels of stigma for failure (Lee et al., 2007). Furthermore, the effect of bankruptcy laws on small entrepreneurial ?rms and
the societal impact of their bankruptcy ?lings can be different from the huge ?nancial impact of corporate bankruptcies of large
incumbent ?rms. The policy implications of bankruptcy laws for these different kinds of bankruptcies may be different, thus
necessitating further in-depth research.
8. Conclusion
Contributing to an institution-based viewof entrepreneurship, we have mapped out howentrepreneur-friendly bankruptcy laws
can stimulate entrepreneurship development around the world. Since “bankruptcy is an occupational hazard for entrepreneurs”
(Economist, 2010: 68), making it less hazardous holds the potential to promote more entrepreneurship. Inconclusion, let us quote the
Economist (2010: 68), which addresses government of?cials desperately searching for ways to promote entrepreneurship and
economic growth in the midst of the worst economic crisis:
Making it easier to close a business may not sound as inviting as announcing yet another “enterprise fund” or “innovation
initiative,” but it is more vital to reviving the world's moribund economy. In the short run, enlightened bankruptcy laws
reduce unemployment by keeping viable companies alive. In the long run they boost rates of entrepreneurship. The best
way to get more people to start businesses is to make it easier to wind them up.
Acknowledgments
We thank Donald Siegel (Editor) and two reviewers for excellent guidance and Livia Markoczy for helpful comments. This work
was supported in part by a National Science Foundation CAREER Grant (SES 0552089). Earlier versions of this article were
presented at the Babson College Entrepreneurship Research Conference (IE Business School, Madrid, Spain, June 2007), Academy
of Management (Philadelphia, August 2007), and Strategic Management Society (San Diego, October 2007). A previous version
received a U.S. Small Business Administration Award for the best Babson Conference paper “exploring the importance of small
businesses to the US economy or a public policy issue of importance to the entrepreneurial community,” presented at the 2008
Babson Conference (University of North Carolina, June 2008) with a press release posted at www.sba.gov/advo/press/08-14.html.
We are grateful to the SBA and to the Best Babson Paper Award Committee (chaired by Andrew Zacharakis) for their
encouragement. All views expressed are those of the authors and not necessarily those of the NSF or the SBA.
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doc_874825108.pdf
How Do Bankruptcy Laws Affect Entrepreneurship Development Around The World
How do bankruptcy laws affect entrepreneurship development around
the world?
Seung-Hyun Lee
a,1
, Yasuhiro Yamakawa
b,
?, Mike W. Peng
a,2
, Jay B. Barney
c,3
a
University of Texas at Dallas, School of Management, 800 West Campbell, SM 43, Richardson, TX 75080, United States
b
Babson College, Arthur M. Blank Center for Entrepreneurship, Babson Park, MA 02457, United States
c
The Ohio State University, Fisher College of Business, 2100 Neil Avenue, Columbus, OH 43210, United States
a r t i c l e i n f o a b s t r a c t
Article history:
Received 20 May 2009
Received in revised form 26 April 2010
Accepted 18 May 2010
Available online 26 June 2010
How do bankruptcy laws as formal institutions affect entrepreneurship development around
the world? Do entrepreneur-friendly bankruptcy laws encourage more entrepreneurship
development at a societal level? We posit that if bankrupt entrepreneurs are excessively
punished for failure, they may give up potentially high-return but inherently high-risk oppor-
tunities to start newbusinesses. Amassing a cross-country database from29 countries spanning
19 years (1990–2008), we ?nd that lenient, entrepreneur-friendly bankruptcy laws are signif-
icantly correlated with the level of entrepreneurship development as measured by the rate of
new ?rm entry.
© 2010 Elsevier Inc. All rights reserved.
Keywords:
Bankruptcy laws
Entrepreneurship
Institutions
Institution-based view
1. Executive summary
Corporate bankruptcies are common. While all entrepreneurs are interested in success, unfortunately a majority of their
ventures fail and many end up in bankruptcy. A challenge confronting policymakers around the world is: How to facilitate more
entrepreneurship development in the face of such odds against entrepreneurial success?
How formal institutions of a society, such as bankruptcy laws, govern bankrupt entrepreneurs and ?rms is an important
component of the institutional framework within which entrepreneurs and ?rms operate. The legal procedures associated with
bankruptcy vary signi?cantly across countries. Some countries provide only limited protection for entrepreneurs and managers of
bankrupt ?rms, while others have more entrepreneur-friendly bankruptcy laws.
A well-known proposition in the literature is that institutions matter—more speci?cally, entrepreneurs and ?rms strategically
respond to the institutional incentives and disincentives. Given the “institutions matter” proposition, more work is needed to help
us understand: How do institutions matter? Thus, two important but unexplored questions we investigate in this study are: How
do bankruptcy laws affect entrepreneurship development aroundthe world? Do entrepreneur-friendly bankruptcy laws encourage
more entrepreneurship development at a societal level?
Amassing a longitudinal, cross-country database covering 29 countries and spanning 19 years (1990–2008, inclusive), we focus
on whether differences in bankruptcy laws are systematically related to the different levels of entrepreneurship development as
measured by the rate of new ?rm entry. Components of entrepreneur-friendly bankruptcy laws include: (1) the time spent on
bankruptcy procedure, (2) the cost of bankruptcy procedure, (3) the opportunity to have a fresh start in liquidation bankruptcy,
Journal of Business Venturing 26 (2011) 505–520
? Corresponding author. Tel.: +1 781 239 4747; fax: +1 781 239 4178.
E-mail addresses: [email protected] (S.-H. Lee), [email protected] (Y. Yamakawa), [email protected] (M.W. Peng), [email protected]
(J.B. Barney).
1
Tel.: +1 972 883 6267; fax: +1 972 883 2799.
2
Tel.: +1 972 883 2714; fax: +1 972 883 6029.
3
Tel.: +1 614 688 3161; fax: +1 614 292 3172.
0883-9026/$ – see front matter © 2010 Elsevier Inc. All rights reserved.
doi:10.1016/j.jbusvent.2010.05.001
Contents lists available at ScienceDirect
Journal of Business Venturing
(4) the opportunity to have an automatic stay of assets, and (5) the opportunity for managers to remain on the job after ?ling for
bankruptcy. By examining the relationship between bankruptcy laws and the value creating activities in a society associated with
new ?rm formation, we predict that entrepreneur-friendly bankruptcy laws may increase the rate of new ?rm entry, which may
be indicative of vibrant entrepreneurial activities in an economy.
Contributing to an institution-based view of entrepreneurship, our research has clear implications for policymakers interested
in entrepreneurship development in an economy and for entrepreneurs assessing their risk when starting up new ?rms. For
policymakers, we suggest that making bankruptcy laws more entrepreneur-friendly will positively affect entrepreneurship
development by lowering exit barriers and entry barriers. For entrepreneurs starting up new ?rms, we suggest that they pay
attention to the nuances of bankruptcy laws in their jurisdiction and that if possible they set up ?rms in a jurisdiction that has
entrepreneur-friendly bankruptcy laws.
2. Introduction
Corporate bankruptcies are common. While all entrepreneurs are interested in success, unfortunately a majority of their
ventures fail and many end up in bankruptcy. A challenge confronting policymakers around the world is: How to facilitate more
entrepreneurship development in the face of such odds against entrepreneurial success?
Entrepreneurship is widely seen as one of the most important drivers of economic growth (Schumpeter, 1942). The level of
entrepreneurship in a particular country is not independent of the broader institutional context that has evolved in that country
(Baumol, 1996; North, 1990). Countries that are characterized by institutions that support entrepreneurial activity will, other
things equal, have higher levels of entrepreneurship than countries characterized by institutions that do not support
entrepreneurship (Acs and Laszlo, 2007; Busenitz et al., 2000; Peng et al., 2009; Peng et al., 2008).
Of course, the institutional context of entrepreneurship in a particular country can have many different elements—ranging
from cultural values concerning risk to beliefs about the stigma associated with entrepreneurial failure (Shepherd, 2003;
Yamakawa, 2009). Research has shown that many of these elements are, in fact, related to the rate of entrepreneurship in a
country (Shane, 1996). Because many of these institutional elements re?ect the evolution of values and beliefs in a country over
long periods of time, they are both relatively stable (Hofstede, 2007) and dif?cult to alter with changes in public policy (North,
1990). However, there are some elements of the institutional context of entrepreneurship within a country that are somewhat
more susceptible to policy manipulations. One of these may be a country's bankruptcy laws—a form of formal institutions
(Gamboa-Cavazos and Schneider, 2007).
Indeed, Lee et al. (2007) have argued that a country's corporate bankruptcy laws (hereafter “bankruptcy laws”) can have an
important impact on the level of entrepreneurship in a country.
4
Lee et al. (2007) posit that bankruptcy laws that reduce the cost of
entrepreneurial exit may increase the level of entrepreneurship in a country, while bankruptcy laws that increase the cost of such
exit may reduce the level of entrepreneurship in a country. Peng et al. (2010) show systematic differences in terms of bankruptcy
laws' entrepreneur-friendliness around the world. It follows from this logic that countries seeking to increase the level of
entrepreneurship can, among other things, adjust their bankruptcy laws to reduce the cost of bankruptcy (Armour and Cumming,
2008; Halliday and Carruthers, 2007).
Of course, a country's bankruptcy laws are not independent of other elements of its broader institutional framework, especially
those elements of its culture that are relevant to entrepreneurial activity. Thus, for example, a country that has a culture that is risk
adverse is more likely to have bankruptcy laws that raise the cost of entrepreneurial failure, while a country with a less risk adverse
culture is likely to have bankruptcy laws that impose lower costs of such failures (Lee et al., 2007; Tezuka, 1999). If, as a matter of
public policy, a country is to use changes in its bankruptcy laws to facilitate more entrepreneurship, the impact of those changes on
the propensity of individuals to become entrepreneurs must be greater than those elements in the institutional context that
continue to be anti-entrepreneurial in nature.
In a nutshell, we address two important yet underexplored questions: How do countries' bankruptcy laws affect the level of
entrepreneurship development as measured by the rate of new?rm entry? Do entrepreneur-friendly bankruptcy laws encourage
more entrepreneurship development at a societal level? We endeavor to contribute to theory building and empirical substantiation
with a focus on diverse entrepreneurship phenomena around the world (Zahra, 2007). We begin by more fully developing the logic
that links bankruptcy laws with the level of entrepreneurship in a country. Then we develop hypotheses linking the speci?c
elements of these laws with entrepreneurial behavior and test them with a sample of 29 countries over a 19-year time period.
While our paper builds on the most relevant earlier work by Lee et al. (2007), Peng et al. (2010), and Armour and Cumming
(2008), ours goes beyond these three papers in at least ?ve signi?cant ways. First, Lee et al. (2007) is a theory paper with no
empirical data. Peng et al. (2010) show qualitative data without empirical testing. Ours is the ?rst paper to deepen and broaden
their theoretical ideas, transform them into testable hypotheses, and empirically test them with worldwide data. While Lee et al.
(2007) and Peng et al. (2010) emphasize the bene?t side of bankruptcy and pay less attention to the important component of the
cost of bankruptcy (Bris et al., 2006; Djankov et al., 2008; White, 1984), we have added the estimation of the direct and overall cost
of the bankruptcy proceedings (e.g., cost of petitioning for insolvency, court fees, fees of practitioners, independent assessors,
lawyers, and accountants). The positive externality discussed in Lee et al. (2007) is also complemented by the negative externality
in our research. Second, Armour and Cumming (2008) is an empirical paper that shares the same basic thrust of our paper—with
4
Although a country's personal bankruptcy laws may also affect entrepreneurship development (Armour and Cumming, 2008; Efrat, 2002; Fan and White,
2003; Mankart and Rodano, 2007), we do not deal with personal bankruptcy laws in this article.
506 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
one important difference. Armour and Cumming (2008) deal with the impact of personal bankruptcy laws on entrepreneurship,
and we focus on the impact of corporate bankruptcy laws. Third, Armour and Cumming (2008) cover 15 developed economies
(two in North America and 13 in Western Europe). Our database covers 29 countries that not only include all the countries studied
by Armour and Cumming (2008), but also 14 additional countries in Asia, Latin America, and Oceania—with substantial
representation of emerging economies. Fourth, Armour and Cumming (2008) mainly examine the aspect of bankruptcy
procedures with the direct relationship with creditors using automatic discharge and exemptions from creditors. This is
understandable since they only examine liquidation bankruptcy, while we examine both liquidation and reorganization
bankruptcies. For this reason, we examine the effect of automatic stay of assets and managers' stay on the job, which are
speci?cally related only to reorganization bankruptcy. Fifth and ?nally, we also examine the potential endogeneity problem in the
relationship between bankruptcy law and entrepreneurship development. Following Klapper, Laeven, and Rajan (2006), we use
an instrumental-variable approach and use legal origin as an instrument for fresh start.
3. Entrepreneurship at the societal level
Starting with Schumpeter (1942), there is ample literature on entrepreneurship at the societal level. For example, McGrath
(1999) argues that uncertainty is not always a bad thing even when most entrepreneurs fail if a few successful entrepreneurs can
generate more value to a society than when all entrepreneurs survive, but hardly add value. At a societal level, this logic suggests
that since a society cannot anticipate, with certainty, which entrepreneurial activities will actually generate economic growth and
prosperity, it should encourage the development of a wide variety of such activities (Birley, 1986; Lumpkin and Dess, 1996). From
a societal standpoint, each of these entrepreneurial activities can be regarded as an experiment (McGrath, 1999). Many of these
will turn out to be economically unsustainable, which may lead to numerous bankruptcies—for example, think of numerous e-
commerce failures. However, some of them may turn out to be economically important—think of Google and Yahoo! Without the
bundle of options created by numerous entrepreneurs, a society may not be able to discover those entrepreneurial activities that
actually create economic growth and prosperity (Lee et al., 2007; McGrath, 1999; Nickell, 1996; Peng et al., 2010).
At a societal level, the unlimited upside potential associated with entrepreneurial actions exists because of the potential
economic value that these actions can create. Limiting the downside risks associated with these activities depends on the cost of
failing as entrepreneurs in a society. Failure, although painful for bankrupt entrepreneurs, may be valuable for the society as a
whole (Hoetker and Agarwal, 2007; Knott and Posen, 2005), because it reveals which entrepreneurial endeavors are not likely to
be sources of economic growth.
4. Hypotheses
Following Lee et al. (2007), Peng et al. (2010), and Armour and Cumming (2008), a broad proposition emerges, suggesting
that bankruptcy laws that reduce the cost of entrepreneurial bankruptcy may, other things equal, increase the rate of
entrepreneurship—speci?cally, entry of new ?rms in a country. However, to generate testable hypotheses consistent with this
broad proposition, speci?c dimensions of bankruptcy laws and how they vary across countries must be identi?ed.
Extending Lee et al. (2007) and Peng et al. (2010), we identify ?ve dimensions of bankruptcy laws and develop testable
hypotheses. As shown in Fig. 1, the ?ve dimensions are: (1) the time spent on bankruptcy procedure, (2) the cost of bankruptcy
procedure, (3) the opportunity to have a fresh start in liquidation bankruptcy, (4) the opportunity to have an automatic stay of
assets, and (5) the opportunity for managers to remain on the job after ?ling for bankruptcy.
Fig. 1. Components of bankruptcy laws and entrepreneurship development.
507 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
4.1. Time spent on bankruptcy procedure
The cost of bankruptcy is positively related to the length of time spent on the bankruptcy procedure (Bebchuk, 2000; Bris et al.,
2006). In a liquidation bankruptcy, a fast procedure allows the quick reallocation of assets of failed ?rms to better uses. At the same
time, a fast procedure can provide an entrepreneur a new opportunity to start a new business. By eliminating failing ?rms and
reallocating resources to better uses, a fast bankruptcy procedure may increase variance in a bundle of ?rms at a societal level.
If a ?rm?les reorganization bankruptcy (such as Chapter 11 in the United States), a fast procedure may protect the value of the
assets of the ?rm and improve its chances for an eventually successful turnaround (Bebchuk, 2000). A lengthy process
characterized by an uncertain outcome, however, may make business partners (such as buyers and sellers) reluctant to maintain
their business relationships. This in turn may reduce earnings and the value of ?rm assets (LoPucki and Doherty, 2002). One study
drawing on data from 88 countries ?nds that on average, it takes 2.64 years to resolve, and on average 48% of the ?rm value is lost
during the highly inef?cient bankruptcy process (Djankov et al., 2008). Not surprisingly, managers may become frustrated with
the long procedure, which distracts them from focusing on more important operations. An inef?cient, time-consuming procedure
may end up forcing a ?rm to liquidate by increasing ?nancial distress, while a fast procedure could have saved the ?rm.
In Japan, even when ?nancially insolvent ?rms decide to ?le for bankruptcy, courts will scrutinize the case and decide
whether to allow certain ?rms to declare themselves bankrupt. In other words, some insolvent ?rms are not allowed to
bankrupt. This procedure alone takes more than three months (Alexander, 1999). It is, therefore, not surprising that in Japan, half
of all liquidations took more than three years and more than 75% of reorganizations exceeded ?ve years from application to
conclusion (Alexander, 1999). Obviously, failed entrepreneurs stuck with existing ?rms going through a lengthy bankruptcy
procedure are not in a position to start new ?rms. Overall, a more ef?cient bankruptcy procedure may encourage more entry of
new ?rms—in Silicon Valley, this is known as the motto of “fail fast, fail cheap, and move on.” In Mexico, post-2000 bankruptcy
reforms have shortened the average bankruptcy process from 7.8 to 2.3 years (Gamboa-Cavazos and Schneider, 2007). In
summary:
Hypothesis 1. Less time spent on the bankruptcy procedure will be positively associated with a higher rate of new entry of ?rms
in a country.
4.2. Cost of bankruptcy procedure
In addition to the lengthy time, the actual cost involved in ?ling bankruptcy may also make entrepreneurs procrastinate about
?ling bankruptcy (Bris et al., 2006). One may think that the direct cost of bankruptcy is not very high. However, the World Bank's
Doing Business Report (2008) ?nds that in the United States, the direct cost is approximately 7% of the assets of the ?rm. Bris et al.
(2006) report a higher percentage for U.S. Chapter 11 bankruptcies: 17%. Internationally, Djankov et al. (2008) ?nd bankruptcy
cost amounts to 14% of the estate cost among 88 countries. It costs 22% when ?rms ?le bankruptcy in Italy and Poland, and 36% in
Thailand (Doing Business Report, 2008). This underscores Mason's (2005: 1523) argument that costly bankruptcy “can cause
sluggish economic growth.” In other words, high bankruptcy cost may discourage ?rms to ?le bankruptcies even when at the
societal level, it may be more valuable for them to go bankrupt so that resources and employees can be channeled toward more
productive use. Also, when the cost associated with bankruptcy is high, some entrepreneurs may be discouraged to start
businesses in the ?rst place. Thus:
Hypothesis 2. Less cost spent on the bankruptcy procedure will be positively associated with a higher rate of newentry of ?rms in
a country.
4.3. Fresh start in liquidation bankruptcy
Bankruptcy laws can either discharge bankrupt individuals from debt or allow the pursuit of bankrupt entrepreneurs for years
(OECD, 1998). By discharging bankrupt entrepreneurs, while creditors can claimresidual assets, they cannot pursue any remaining
claims. Since an entrepreneur's future earnings are exempt from the obligations to repay past debt from bankruptcy, this type of
bankruptcy laws are appropriately called “fresh start” laws (Ayotte, 2007; White, 2001). In the absence of a legally protected “fresh
start,” creditors can pursue any remaining claims, at least for some de?ned period of time. In Germany, until the recent bankruptcy
law reforms (Armour and Cumming, 2008), the debtor would remain liable for unpaid debt for up to 30 years (Ziechmann, 1997)
and managers at bankrupt ?rms can be personally liable for criminal penalties (Fialski, 1994). It is not surprising that German
entrepreneurs would have to think twice before starting up new ?rms.
In addition, the 1997–1998 Asian economic crisis revealed that the lack of protection against creditors actually kept many ?rms
from?ling bankruptcy even when it would have made more sense to ?le (Chang, 2006; New York Times, 1998). For executives of
?rms in distress who knowthat the consequences of bankruptcy would hurt thempersonally, ?ling a bankruptcy is likely to be the
last thing they have in mind. This means that many ?rms that should not be alive continue to survive—in essence, “dead men
walking,” a huge opportunity cost to the overall economy (Limand Hahn, 2003). Once these economically unviable ?rms are given
the chance to ?le bankruptcy more easily, some entrepreneurs would be able to start new businesses. Thus:
Hypothesis 3. Discharging bankrupt entrepreneurs more from debt to allowthem to have a “fresh start” will be associated with a
higher rate of new entry of ?rms in a country.
508 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
The ?rst three dimensions we examined above are: (1) time spent on bankruptcy procedure, (2) cost of bankruptcy procedure,
and (3) fresh start in liquidation bankruptcy. We argue that these three dimensions positively affect the rate of newentry because
?rms would be affected by these dimensions regardless of the capabilities of the entrepreneurs. However, the two additional
dimensions, (1) automatic stay of assets in reorganization bankruptcy and (2) the fate of managers, may have different
implications depending on how entrepreneurs are salvaged by the two dimensions, respectively.
Automatic stay of assets is about providing another opportunity to an unfortunate entrepreneur who is capable, but is under
?nancial trouble. For this reason, the automatic stay of assets may extend the economic viability of entrepreneurs and their current
?rms. If the economic viability of entrepreneurs and their current ?rms is extended, they may be less motivated to start new?rms,
thus resulting in a smaller number of new ?rm entries in the next stage. In other words, while nascent entrepreneurs may see
automatic stay of assets as an incentive to start new ?rms, those who are already in business may not come back to restart
businesses once they successfully revive their current ?rms in trouble. It is the same with the fate of managers. Should the
managers stay and revive the ?rms in trouble, they may be less motivated to start new ?rms.
4.4. Automatic stay of assets in reorganization bankruptcy
In some countries, bankruptcy laws may come with an automatic stay of assets and discharge some portion of debt. An
automatic stay upon the start of bankruptcy proceedings means that creditors must cease debt collection efforts and move claims
to the court (Alexopoulos and Domowitz, 1998). The ?rm continues to operate while creditors and ?rms negotiate (Kaiser, 1996).
Before deciding whether the ?rm should be liquidated or not, an automatic stay allows time for managers to communicate with
creditors (Franks et al., 1996). La Porta et al. (1998) ?nd that nearly half of the 49 countries they study do not have an automatic
stay on assets. While automatic stay is allowed in the United States in the case of reorganization bankruptcy (such as Chapter 11),
countries such as Germany, Great Britain, and Japan do not guarantee automatic stay of assets (Alexander, 1999; Hashi, 1997).
In an economy where secured creditors are allowed to repossess their assets when a ?rm?les reorganization bankruptcy, it can
end up in premature liquidations (Broadie et al., 2007). Given uncertainty over the future potential of the ?rm, even when the
value of the ongoing concern is higher than liquidation value, some creditors may have a greater interest in liquidating the ?rm
(Broadie et al., 2007; Wruck, 1990). In Germany, for example, automatic stay does not extend to secured creditors and these
secured creditors have incentives to pursue liquidation bankruptcy (Kaiser, 1996). Therefore, when automatic stay is not in place,
many ?rms do not have the opportunity to ?le a reorganization bankruptcy even when this option is legally allowed. Thus, in turn,
when entrepreneurs knowthat they would not be given a second chance when their ?rms are undergoing dif?culty, some of them
would be discouraged to start new businesses.
While we have not speci?cally examined the downside of lenient bankruptcy laws in the previous three hypotheses, these laws
have costs as well (Lee et al., 2007: 266; see Bebchuk, 2002; Kahl, 2002). Banks may strictly screenpotential entrepreneurs attempting
tosecure ?nancing due to more lenient bankruptcy laws. Inother words, debt forgiveness of failedentrepreneurs may come backwith
an increased cost of ?nancing to potential entrepreneurs, which may become a source of discouragement. Less time and less cost in
bankruptcy procedures can lower the burden of failed entrepreneurs, but at the same time can increase the cost to the banks.
This is not different for the case of fresh start. Fresh start mandates that failed entrepreneurs are exempt from repaying
outstanding obligations (Ayotte, 2007). While residual assets can be claimed, banks cannot pursue for any remaining claims at a
bankruptcy. Since entrepreneurs are exempt fromthe obligations to repay past debts frombankruptcy with future earnings, it can
be very costly to the banks (White, 2001). However, in the absence of a legally protected “fresh start,” creditors can pursue any
remaining claim(Broadie et al., 2007). Maybe this is why past research shows that other than the leniency of the bankruptcy laws,
the level of easy ?nancing is an important factor in new?rm entry (Armour and Cumming, 2008). Not surprisingly Berkowitz and
White (2004) ?nd that in the United States, the rejection rate for ?nancing is over 30% higher in states with unlimited bankruptcy
exemptions compared to states with low exemptions. Thus:
Hypothesis 4a. An automatic stay of assets speci?ed by bankruptcy laws will be positively associated with a higher rate of new
entry of ?rms in a country.
On the other hand, if debt holders in a country have limited ability to secure repayment of their loans to bankrupt ?rms, they
may be forced to increase the cost of ?nancing. In a sense, the increased risk of receiving payment from a bankrupt ?rm for ?rms
operating in countries with automatic stay of assets will be re?ected in the cost of debt capital for these ?rms (Broadie et al., 2007).
This is why past research shows that how easy it is to gain access to ?nancing is an important factor in entrepreneurship devel-
opment (Armour and Cumming, 2008; Mankart and Rodano, 2007). In other words, the opportunity cost of securing loans is the
interest rate that entrepreneurs have to bear (Choi and Phan, 2006; Shane, 1996). A high cost of ?nancing, in turn, may reduce the
number of entrepreneurial entrants in a country.
In addition, if these entrepreneurs are successful in their turnaround attempt, they would be staying with the current ?rms,
which will not necessarily result in the founding of new ?rms. This is why entrepreneurs can often successfully turn around their
?rms in temporary ?nancial trouble in countries where an automatic stay of assets is well protected. For example, in the United
States, Harvard Industries' nick name is Chapter 44 because it ?led reorganization bankruptcy four times (Economist, 2002). Thus,
we suggest a competing hypothesis:
Hypothesis 4b. An automatic stay of assets speci?ed by bankruptcy laws will be positively associated with a lower rate of new
entry of ?rms in a country.
509 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
4.5. The fate of managers
Managers make ?rm-speci?c investments during their tenure with a ?rm. This ?rm-speci?c knowledge would be most
required when a ?rm is in ?nancial distress. The opportunity to stay with the ?rm after ?ling for reorganization bankruptcy
provides incentives for managers to make ?rm-speci?c investments. If managers are going to be driven out when a ?rm ?les
reorganization bankruptcy, they may lack incentives to make ?rm-speci?c investments in the ?rst place (Shleifer and Summers,
1988). If managers know ex ante that they will not be automatically replaced in the case of bankruptcy, however, the opportunity
to stay with the ?rmmay work as a “bonding device” (Gaston, 1997). Thus, when a ?rm?les bankruptcy, providing an opportunity
for managers to stay may provide managers a better chance to revive the ?rm.
Since ?rms are heterogeneous, ?rm-speci?c investments by managers would increase variety and value in a bundle of ?rms
(Barney, 1991). On the other hand, in a manager-replacement systemsuch as a trustee-appointment system, appointing outsiders
without ?rm-speci?c knowledge for reorganization may end up with improper reorganization (Alexander, 1999; Hashi, 1997). For
example, Chapter 11 in the United States allows managers to retain control of the ?rm and provides them the exclusive right to
propose reorganization plans. In contrast, in Great Britain and Germany, control rights are rendered to secured creditors (Franks et
al., 1996). It is not surprising that the practice of allowing secured creditors to take over has been criticized for the reason of
premature liquidation (Kaiser, 1996). Thus, in turn, when entrepreneurs know that they would not be given a second chance to
revive their ?rms under dif?culty, some of them may be discouraged to start new businesses in the ?rst place. On the other hand,
when entrepreneurs are given opportunities to stay on the job and work on the revival of the troubled ?rms, they may be more
willing to take risk and start businesses. Overall:
Hypothesis 5a. Allowing incumbent managers to stay on the job speci?ed by bankruptcy laws rather than forcing out incumbent
managers will be associated with a higher rate of new entry of ?rms in a country.
However, just as making it dif?cult for creditors to secure repayment on their debt can increase the cost of ?nancing and
potentially reduce the level of new ?rm entry in a country, so too can limitations of the ability of outside stakeholders to replace
management increase the cost of capital and other critical resources for entrepreneurial ?rms. Potentially one rationale for
allowing managers to stay with the failing ?rm may be based on an assumption that the factors leading to the ?nancial trouble of
the ?rm are largely exogenous (Daily, 1994; Moulton and Thomas, 1993). However, after all, it is under the care of the incumbent
managers that the ?rm has gone bankrupt. An argument can be made that letting the failed managers stay with the ?rm that is
already in trouble may only give them another opportunity to destroy value. Because managers can take advantage of this special
treatment of letting them stay during times of dif?culty, some scholars call this type of move as a “strategic bankruptcy (Moulton
and Thomas, 1993). Thus, letting failed managers stay in their positions when a ?rmis in ?nancial distress may increase the cost of
capital. This, in turn, can also have a negative impact on the rate at which entrepreneurship emerges in a country.
In addition, as argued above, if entrepreneurs are more likely to turn around their ?rms, they would stay with the ?rm rather
than starting new businesses. For this reason, it is quite possible that letting managers stay with the ?rm at the time of
reorganization bankruptcy may dampen the new entry of ?rms. Speci?cally:
Hypothesis 5b. Allowing incumbent managers to stay on the job speci?ed by bankruptcy laws rather than forcing out incumbent
managers will be associated with a lower rate of new entry of ?rms in a country.
In summary, Hypotheses 1, 2, and 3 suggest an unambiguous relationship between entrepreneur-friendly bankruptcy laws and
the rate of entrepreneurship in a country as measured by the entry of new ?rms. These hypotheses focus directly on the cost of ?ling
for bankruptcy—minimizing such cost is economically ef?cient for all of a ?rm's stakeholders (Lee et al., 2007; Peng et al., 2010).
Hypotheses 4a–4b and 5a–5b suggest contradictory relationships between bankruptcy laws and the entry of new?rms into a country.
This is because these two sets of hypotheses focus on howthe problems that would lead a ?rmto declare bankruptcy are resolved. If the
process by which these problems are resolved favors managers (as in Hypotheses 4a and 5a), then that may give individuals more
incentives to become entrepreneurs. On the other hand, those incentives may be counter-balanced by the increased costs that
entrepreneurs would have to bear to compensate other stakeholders for the increased risks they would have to bear, in the face of
bankruptcy(Bebchuk, 2002; Broadieet al., 2007; Kahl, 2002). Theseincreasedcosts mayreducethelevel of new?rmentries inacountry.
The net effect of Hypotheses 4a versus 4b and of Hypotheses 5a versus 5b, on the entry of new?rms into a country's economy,
is ultimately an empirical question (Bebchuk, 2002: 457). However, if the size of these contradictory effects is approximately
equal, these relationships may cancel each other and result in non-signi?cant ?ndings.
5. Methods
5.1. Data
We have collected data for 29 countries during a 19-year period (1990–2008, inclusive). Our sources include past studies on
commercial bankruptcy ?lings collected from government and private sources (Claessens and Klapper, 2005),
5
on the legal rules
covering protection of corporate shareholders and creditors, their origin, and the quality of their enforcement (La Porta et al.,
5
We thank Stijin Claessens and Leora Klapper for sharing part of their data for our research.
510 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
1998), and on the regulation of entry (Djankov et al., 2002). We have also collected additional data fromsources such as the World
Bank,
6
the Organization for Economic Co-operation and Development (OECD), the World Health Organization (WHO), and the
International Monetary Fund (IMF). Table 1 outlines our data across the 29 countries.
It is natural for the bankruptcy variables to correlate with each other. But, according to the correlation table, there are some
exceptions. For example, the correlations between the closing time and the automatic stay of assets and the closing time and the
stay of incumbent management are not signi?cant. This is probably because while closing cost and closing time are part of the
overall administrative costs decided at the court and related to liquidation bankruptcy, automatic stay of assets and stay of
incumbent management are decided by the legislature and associated with liquidation bankruptcy. We also observe that not all
the bankruptcy variables are positively correlated. This suggests that many countries may have developed bankruptcy laws in a
piece-meal manner (De Soto, 2003).
5.2. Dependent variable
In our hypotheses, we predict how various components of the bankruptcy laws can curtail the downside risk of entrepreneurs
and help encourage risk-taking behavior such as new ?rm entry. The dependent variable in our model is thus the rate of new ?rm
entry (Kawai and Urata, 2002; Klapper et al., 2006; Yamawaki, 1991). We use OECDdata on the ratio of the number of new?rms to
the total number of ?rms (previous year) in a country.
7
5.3. Independent variables
5.3.1. Closing time
The data are obtained from the World Bank (Djankov et al., 2008). Closing time refers to the average time (in years) to
complete a bankruptcy procedure within a country. Since we argue that a shorter time for bankruptcy procedure is associated with
a higher rate of bankruptcy ?ling, we reverse the signs of the lengths of time from positive to negative.
6
Doing Business Report, International Finance Corporation, The World Bank Group (http://www.ifc.org).
7
For certain instances, the OECD did not provide the rate of new ?rm entry but provided data on the number of ?rms in total in a particular year end (T
t
) and
the number of ?rms that ?led bankruptcy in a particular year end (D
t
). In these cases, we calculated the number of entries (B
t
) by T
t
=B
t
+T
t ?1
?D
t
so that
B
t
=T
t
?(T
t ?1
?D
t
), whereas the rate of new ?rm entry BR
t
=B
t
/ T
t ?1
.
Table 1
New ?rm entry rates (the ratio of new ?rms to the total number of ?rms) and bankruptcy law differences.
Sources: Claessens and Klapper, 2005; Doing Business Report, World Bank; La Porta et al., 1998; OECD data.
Country New ?rm entry
rate
a
Time (years) spent
on bankruptcy
a
Cost (% of estate)
of bankruptcy
a
Fresh start
(recovery rate:
cents/$)
a
Automatic stay of
assets (1: stay;
0: no stay)
Stay of incumbent
management
(1: stay; 0: no stay)
Argentina 0.07 2.8 14.6 75.9 1 1
Australia 0.11 1.0 8.0 19.9 1 1
Austria 0.08 1.1 18.0 26.9 0 1
Belgium 0.07 0.9 4.0 13.9 0 1
Canada 0.10 0.8 4.0 10.4 1 1
Chile 0.07 5.5 17.5 79.8 1 1
Denmark 0.10 3.2 4.0 35.0 0 1
Finland 0.08 0.9 4.0 11.6 1 1
France 0.08 1.9 9.0 53.9 1 1
Germany 0.17 1.2 2.2 44.2 0 1
Greece 0.06 2.0 9.0 55.3 1 0
Hong Kong 0.04 1.1 9.0 19.1 0 0
Ireland 0.05 0.4 9.0 12.3 1 1
Italy 0.08 1.3 18.7 52.4 1 1
Japan 0.04 0.6 4.0 7.4 1 0
Netherlands 0.09 1.1 4.0 12.5 1 1
New Zealand 0.20 1.3 4.0 21.2 0 0
Norway 0.11 0.9 1.0 6.5 1 1
Peru 0.11 3.1 7.0 69.8 1 1
Portugal 0.09 2.0 9.0 26.6 1 1
Singapore 0.18 0.8 1.0 8.7 0 0
South Korea 0.03 1.5 4.0 18.9 0 0
Spain 0.10 1.0 15.0 22.6 0 1
Sweden 0.07 2.0 9.0 28.3 1 1
Switzerland 0.02 3.0 4.0 53.5 1 1
Thailand 0.09 2.7 36.0 59.4 0 0
Turkey 0.04 3.3 15.0 88.3 1 1
United Kingdom 0.13 1.0 6.0 14.7 0 0
United States 0.10 1.5 7.0 20.1 1 1
a
Average during 1990–2008.
511 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
5.3.2. Closing cost
Similarly, we use data provided by the World Bank to measure the cost associated with bankruptcy ?lings (Djankov et al.,
2008). Closing cost represents the cost of the bankruptcy proceedings (% of estate). Again, to align with our argument that a lower
cost of bankruptcy is associated with a higher ?ling rate, we reverse the signs from positive to negative.
5.3.3. Fresh start
We use the rate of recovery froma closing to measure the degree of an entrepreneur's fresh start as speci?ed by the bankruptcy
laws. Since the likelihood of pursuits of remaining claims is associated with closing recovery, we use this variable to proxy for an
entrepreneur's fresh start. Closing recovery exhibits the recovery rate, which calculates how many cents on the dollar claimants
such as creditors, tax authorities, and employees recover froman insolvent ?rm. We assume that the greater the claimants recover
from an insolvent ?rm, the less is recovered by entrepreneurs themselves, thereby the less likely they will have a fresh start. In
order to align with our argument that lower recovery by others is associated with higher ?ling rate, we calculate fresh start as one
dollar (100 cents) minus the rate of recovery as cents per dollar by others such as creditors, tax authorities, and employees. Data
for this variable are also obtained from the World Bank.
5.3.4. Automatic stay of assets
We use data originally collected by La Porta et al. (1998) and frequently used in subsequent research (Claessens and Klapper,
2005; Peng et al., 2010; Pistor, 2000). This variable represents one of the dummy variables created in La Porta et al. (1998),
whether or not the reorganization procedure imposes an automatic stay on the assets, thereby preventing secured creditors from
getting possession of loan collateral. Whereas La Porta et al. (1998) de?ne it “no automatic stay on secured assets,” here, we label it
reversely as “automatic stay of assets.” Accordingly, this variable equals to 1 if there is automatic stay of assets; and 0 otherwise
that such a restriction does not exist in the law.
5.3.5. Stay of incumbent management
This variable also refers to one of the dummy variables that constitute La Porta et al.'s (1998) index of creditor rights. La Porta et
al. (1998) label this as “management does not stay,” which we label here reversely as “stay of incumbent management.”
Accordingly, the variable equals to 1 if incumbent management stays during a restructuring or bankruptcy; and 0 otherwise (i.e.,
when an of?cial appointed by the court, or by the creditors, is responsible for the operation of the business during reorganization,
or when the debtor does not keep the administration of its property pending the resolution of the process).
5.4. Control variables
We control for six sets of factors. First, we expect that economic performance of a country would affect its rate of new?rmentry
(Shane, 1996). Countries experiencing positive growth may have higher rates of new?rmentry (Kawai and Urata, 2002). Thus, we
control for countries' general level of development and macroeconomic performance. For general development, we include lagged
real GDP per capita in US dollars. For macroeconomic performance, we include the growth rate of real GDP lagged one year
obtained fromthe IMF (Claessens andKlapper, 2005). In addition, we control for the interest rate as well as the number of banks per
capita withina country ina givenyear inorder to capture the variance and stability of a country's ?nancing infrastructure (Bandiera
et al., 2000; Caprio and Honohan, 1999; Goderis and Ioannidou, 2008).
Second, in our attempt to control for unobserved regional effects, we create dummy variables for regions (e.g., Europe, Asia)
with North America as the reference category. Differences in national institutions can bring about different levels of
entrepreneurial activity across countries (Baumol, 1996; Busenitz et al., 2000; North, 1990). We control for regions to account
for these differences explained by a broader set of institutions that guides and constrains entrepreneurial behavior. We also
control for general institutional quality that may in?uence new?rm entry rates in other forms than bankruptcy, such as ef?ciency
of law. We account for this by controlling for the “rule of law”—an assessment of the law and order tradition within a country
(Claessens and Klapper, 2005; La Porta et al., 1997, 1998).
Third, we control for time effects across all countries (Caprio and Klingebiel, 2002). We include a variable measuring
years elapsed from 1990 to capture any time trend effects associated with changes in the bankruptcy rate (Rhee and Haunschild,
2006).
Fourth, we control for differences in the informal aspects of the institutional environment, such as “uncertainty avoidance,”
obtained from Hofstede (2001). In other words, the same entrepreneur-friendly bankruptcy laws may have different implications
for entrepreneurs in different institutional environments (Lee et al., 2007; Sutton and Callahan, 1987).
Fifth, we control for the of?cial cost of all procedures required to register a ?rm expressed as percentage of gross national
income [GNI] per capita, using World Bank data. Finally, since the rate of exit (previous year) and the rate of new entry (the
following year) may be positively correlated, we control for bankruptcy rate (previous year).
5.5. Model speci?cation
We model the rate of new ?rm entry using the following power function:
ER
i; t
= BR
a
it?1
exp ?CT
it?1
+ ?CC
it?1
+ ?RR
it?1
+ ?SA
it?1
+ iMS
it?1
+ ?C
it?1
ð Þ? ðIÞ
512 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
where
ER
i, t
the rate of new ?rm entry in a given country i at a given year t
BR
it ?1
the bankruptcy rate in a given country i at a given year t ?1
CT
it ?1
the average closing time (in years) to complete a bankruptcy procedure in country i during year t ?1
CC
it ?1
the average closing cost (% of estate) of the bankruptcy proceedings in country i during year t ?1
RR
it ?1
the recovery rate (cents on the dollar) of bankruptcy ?lings in country i during year t ?1
SA
it ?1
a dummy variable indicating whether the reorganization procedure allows an automatic stay of assets (1) or otherwise
(0) in country i during year t ?1
MS
it ?1
a dummy variable indicating whether the incumbent management is allowed to stay (1) or otherwise (0) in country i
during year t ?1
C
it ?1
a vector of control variables (described below) in country i during year t ?1
? a log normally distributed error term.
By transforming Eq. (I) to its natural logarithm, we obtain the linear equation with a normally distributed error term, ?:
Log ER
i;t
= ?log BR
it?1
ð Þ + ?CT
it?1
+ ?CC
it?1
+ ?RR
it?1
+ ?SA
it?1
+ i MS
it?1
+ ?C
it?1
+ ? ðIIÞ
We use a logarithm transformation to allow our dependent variable (percentage) to take both positive and negative values
rather than being constrained to be positive. This log-linear model is commonly used in econometric estimation for percentage
changes, and is more consistent with the assumption of normally distributed error terms (Greene, 2000).
5.6. Estimation
We estimate the parameters of Eq. (II) on unbalanced, pooled, cross-national, time-series data with yearly time periods. Since
we do not have the same number of years for which we have observations on bankruptcy rates for each country, the number of
observations varies among countries. Due to missing data, we have a total of 229 country-year observations.
8
In order to take into account both inter- and intra-variations among country observations, we use the generalized estimating
equations (GEE) to test our hypotheses (Liang and Zeger, 1986; Rhee and Haunschild, 2006). Since our dataset contains multiple
and unbalanced observations for each country, we use this estimation technique as a superior approach than a standard Ordinary
Least Squares (OLS)-based regression models. Because observations for countries are organized into a pooled cross-sectional time-
series dataset, there will be potential for non-independence and cross-sectional heteroskedasticity. Thus, OLS-based estimates
could produce correlated error terms, under-stated standard errors, and in?ated t-statistics (Holcomb et al., 2009). Speci?cally, we
use the identity link, the Gaussian distribution, and the exchangeable option of the correlation matrix in order to correct for the
correlation from repeated observations made for each country (Rhee and Haunschild, 2006). Furthermore, we also use the cluster
command in STATA to obtain a robust variance estimate that accounts for (and adjusts for) within-country correlation and within-
group dependence (Barkema and Shvyrkov, 2007; Williams, 2000).
5.7. Marginal effects
In order to assess the economic signi?cance, we examine the marginal effects of independent variables on the dependent
variable. Economic signi?cance of marginal effects depends on the magnitude of change in the independent variables. However,
since coef?cient estimates are dif?cult to interpret (Greene, 2000), we use the mfx command in STATA to obtain the elasticities of
the form dy/ dx at the desired values of independent variables to calculate the marginal effects of independent variables
(Nickerson and Silverman, 2003).
6. Findings
Table 2 presents descriptive statistics. In order to capture any possible multicollinearity problems associated with high
correlation, we ?rst check all variance-in?ation factors (VIFs), tolerance, and condition indexes. While individual VIFs greater than
10, the average VIF greater than 6, and the individual tolerance less than 0.1 are generally seen as indicative of severe
multicollinearity, the maximum VIF of our data is 5.32, the mean VIF is 2.40, and none of the tolerance is less than 0.1, suggesting
little problem of multicollinearity.
Table 3 presents the GEE estimates on the changes in the rate of new?rmentry derived fromEq. (II). Model 1 is the base model
containing only the control variables. Models 2 to 6 represent the main effect of each of our independent variables. Model 7 is our
?nal model containing all key variables.
8
For example, STATA dropped observations due to missing number of banks. The main cause, however, was due to the lack of data availability on the rate of
new ?rm entry among country-year observations (i.e., we start with 551 possible observations from a 19-year-and-29-country panel, and end up with 229
observations for valid analysis).
513 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
Table 2
Descriptive statistics and Pearson correlation coef?cients — 29 countries, 1990–2008.
Source: Variable 1 (OECD Data); Variables 2–4 (World Development Indicators); Variables 5, 11 (Claessens and Klapper, 2005); Variables 7, 15, 16 (La Porta et al., 1998); Variable 9 (Hofstede, 2001); Variables 10, 12–14
(Doing Business Report, World Bank).
Variable Mean S.D. Min. Max. 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
1. Log [new ?rm
entry rate]
?2.47 .50 ?4.30 ?1.41
2. Log [GDP/capita
(t ?1)]
9.47 .93 7.19 10.94 ?.03
3. GDP growth
(t ?1)
3.34 3.22 ?12.57 12.82 ?.00 ?.10 **
4. Interest rate
(t ?1)
6.42 7.13 ?18.95 72.26 .06 ?.32 *** ?.24***
5. Log [number of
banks/capita]
?4.81 1.61 ?8.19 ?.34 .12* .31 *** .04 ?.04
6. Asia .17 .37 0 1 ?.33*** ?.07 * .19*** ?.05 ?.11***
7. Europe .59 .49 0 1 .03 .32 *** ?.21*** ?.13 *** .21*** ?.54 ***
8. Rule of law
(judicial
ef?ciency)
8.11 2.19 2.08 10 .25*** .80 *** ?.16*** ?.32 *** .24*** ?.19 *** .43 ***
9. Years since
1990
9.71 5.31 0 18 .35*** .10 *** .10* ?.19 *** .07* ?.00 ?.01 ?.04
10. Uncertainty
avoidance
63.09 26.13 8 112 ?.22*** ?.23 *** ?.05 .09 ** ?.05 ?.05 .01 ?.24*** ?.02
11. Log [start-up
cost (t ?1)]
1.74 1.34 ?2.30 3.70 .19*** ?.58 *** .01 .28 *** ?.08* .02 ?.04 ?.61*** ?.03 .50 ***
12. Log
[bankruptcy
rate (t ?1)]
?.19 1.52 ?5.19 2.45 .24*** .41 *** ?.13*** ?.22 *** .17*** ?.17 *** .13 *** .48*** .07 * ?.54 *** ?.48 ***
13. Closing time ?2.36 2.33 ?9.5 ?.1 .53*** .22 *** .02 ?.04 .02 ?.09 ** .06 .17*** ?.01 ?.03 ?.12 *** .07*
14. Closing cost ?12.93 11.89 ?45 ?1 .62*** .30 *** ?.07* .04 ?.04 ?.40 *** .16 *** .25*** .01 ?.22 *** ?.27 *** .17*** .51 ***
15. Fresh start 38.48 24.70 5.6 99.6 .39*** ?.64 *** .07* .21 *** .04 ?.16 *** ?.12 *** ?.46*** .04 .14 *** .31 *** ?.15*** ?.32 *** ?.16***
16. Automatic stay
of assets
.65 .48 0 1 ?.20*** ?.06 ?.08** ?.00 ?.00 ?.32 *** ?.02 ?.06 ?.01 .26 *** .28 *** .13*** ?.11 *** .03 .11 ***
17. Stay of
incumbent
mgmt
.70 .46 0 1 .08 .15 *** ?.13*** .01 .16*** ?.57 *** .36 *** .28*** ?.02 .17 *** .09 * .13*** ?.05 .10*** ?.07 * .46***
Note: t denotes current year.
*
pb0.10.
**
pb0.05.
***
pb0.01.
5
1
4
S
.
-
H
.
L
e
e
e
t
a
l
.
/
J
o
u
r
n
a
l
o
f
B
u
s
i
n
e
s
s
V
e
n
t
u
r
i
n
g
2
6
(
2
0
1
1
)
5
0
5
–
5
2
0
The effect of closing time and closing cost exhibit positive and signi?cant (pb.01) results, therefore supporting both
Hypotheses 1 and 2. In other words, the less time and less costs associated with bankruptcy proceeding are associated with a
higher rate of new ?rm entry in the next year (there is a one-year lag in all models). The signi?cant (pb.05) and positive effect of
fresh start also provides support for Hypothesis 3. The result shows that the more entrepreneurs recover from bankruptcy (which
would mean a fresher start), the higher the rate of new?rm entry in a country. Furthermore, the signi?cant (pb.05) and negative
effect of automatic stay of assets supports Hypothesis 4b but not 4a. The result indicates that allowing assets to stay is not
associated with a higher rate of new ?rm entry; rather, it works the other way around. Finally, neither Hypotheses 5a nor 5b are
supported.
Table 4 presents the marginal effects of our main variables. The results show the magnitude of the effects of independent
variables on the dependent variable—computed in terms of a unit change in the dependent variable associated with a change in
one standard deviation in each independent variable from the mean shown in Table 2. When it comes to a dummy variable, it is a
change fromzero to one. The results indicate that 0.03 year (approximately 10 days) spent on closing time compared to 2.36 years
(approximately 29 months) is associated with a 10% increase in the likelihood of a new ?rm entry. The difference between 1.04%
and 12.93% of estate spent on closing cost translates into an 11% higher likelihood of new?rmentry as well. When it comes to fresh
start, securing 63.18% of the assets means an 11% higher likelihood of new?rmentry compared to when an entrepreneur can only
secure 38.48% of the assets. Finally, when automatic stay of assets is guaranteed, there is an 8% decrease in the likelihood of a new
?rm entry.
In terms of robustness checks, we have tested various additional models (e.g., unconditional speci?cation without the controls,
with only the most basic controls) as well as incorporated various other variables in addition to the main control variables. In order
to correct for unobserved period effects or convergence forces such as large positive shock in ?rm entry, we have included year
dummies for the 19 years. To account for the social dimension of bankruptcy laws, we have controlled for the level of social stigma
Table 3
GEE estimates of new ?rm entry rate — 29 countries, 1990–2008.
Variable Model 1 Model 2 Model 3 Model 4 Model 5 Model 6 Model 7 Hypothesis testing
Log [GDP/capita (t ?1)] ?.000 ** ?.000*** ?.000*** ?.000* ?.000 ** ?.000*** ?.000***
(.000) (.000) (.000) (.000) (.000) (.000) (.000)
GDP growth (t ?1) .007 .005 .006 .007 .008 .008 .003
(.005) (.005) (.005) (.005) (.006) (.005) (.005)
Interest rate (t ?1) ?.004 ?.006 ?.003 ?.004 ?.004 ?.004 ?.007
(.005) (.005) (.004) (.005) (.005) (.005) (.004)
Log [number of banks/capita] .001*** .001*** .002*** .001** .001** .001*** .001***
(.000) (.000) (.000) (.000) (.000) (.000) (.000)
Asia ?.589 ** ?.468** ?.096 ?.501** ?.797 *** ?.727*** .010
(.241) (.186) (.168) (.240) (.227) (.250) (.190)
Europe ?.294 ** ?.238* ?.137 ?.257** ?.383 *** ?.298** ?.168
(.142) (.133) (.125) (.130) (.105) (.126) (.107)
Rule of law (judicial ef?ciency) .107** .081* .057 .124*** .087** .109*** .049
(.043) (.049) (.044) (.047) (.042) (.039) (.048)
Years since 1990 .008 .008 .015** .008 .006 .009 .008
(.008) (.007) (.007) (.009) (.008) (.008) (.007)
Uncertainty Avoidance ?.003 ?.005* ?.002 ?.003 ?.003 ?.003 ?.002
(.003) (.003) (.002) (.003) (.003) (.003) (.003)
Log [start-up cost (t ?1)] .007 .003 .003 .008* .010** .008* .005*
(.005) (.004) (.005) (.004) (.004) (.005) (.003)
Log [bankruptcy rate (t ?1)] ?.025 ?.023 .002 ?.035 .037 ?.018 .022
(.036) (.030) (.040) (.038) (.035) (.038) (.038)
Closing time .081*** .051** Hypothesis 1 supported
(.022) (.022)
Closing cost .031*** .024*** Hypothesis 2 supported
(.003) (.004)
Fresh start .004** .005** Hypothesis 3 supported
(.002) (.002)
Automatic stay of assets ?.410 *** ?.308** Hypothesis 4b supported
(.127) (.123)
Stay of incumbent mgmt .206 .203 Hypotheses 5a and 5b
not supported
(.186) (.162)
Constant ?2.830*** ?2.198 *** ?2.055 *** ?3.205 *** ?2.395*** ?2.686 *** ?2.292 ***
Wald Chi-squared 71.01*** 78.98*** 304.38*** 95.32 *** 57.47*** 79.54*** 397.44***
Marginal R-squared .266 .515 .663 .306 .351 .285 .732
D.f. 11 12 12 12 12 12 16
N 229 229 229 229 229 229 229
Note. Semi-robust standard errors in parentheses; t denotes current year.
*
pb0.10.
**
pb0.01.
***
pb0.10.
515 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
concerning failure by incorporating the suicide rate (by year, per 100,000 populations) obtained fromthe WHO.
9
We have also tested
the number of days and the number of procedures to start a business obtained from the Doing Business Report (World Bank). Since
personal bankruptcy laws may apply more to smaller ?rms and that the distribution of ?rm size may affect the occurrence of
bankruptcies, following Claessens and Klapper (2005), we also use the percentage of employment attributed to small- and medium-
sized enterprises (SMEs) as a control. Furthermore, we have also tried the rate of new ?rm entry in the previous year as a control
variable to see if the previous level of new?rmentry affects the rate of new?rmentry in a given year. Finally, in order to account for
measurement error in our dependent variable, we have created the average new?rmentry rate over the time period and tested our
hypotheses (Armington and Acs, 2002). The results are not qualitatively different from our main ?ndings.
10
Another robustness check that we have added is an attempt to tease out the possibility of reverse causality. We utilize an
instrumental-variable approach (Klapper et al., 2006; Kwok and Tadesse, 2006) and test several variables as an instrumental
variable. Among the bankruptcy law variables, Fan and White (2003) argue that fresh start is the most important variable for
entrepreneurs since its impact can be enormous. We also ?nd that among the ?ve bankruptcy variables, fresh start is the only
variable that has a signi?cant relationship with interest rate and the relationship is positive. This shows that fresh start may be the
most important variable when it comes to debt forgiveness. For this reason, following Klapper et al. (2006), we use legal origin as
an instrument for fresh start. In the ?nance and economics literature, using such an institutional variable is customary (Kwok and
Tadesse, 2006). Speci?cally, we use the ivreg command and robust option in STATA to obtain a robust estimate. We ?nd the results
are qualitatively similar to the original results we have obtained.
7. Discussion
7.1. Contributions
Overall, at least three contributions emerge. First, this paper leverages insights from the past literature to address an
entrepreneurship issue that has important public policy implications (Acs and Laszlo, 2007; Cumming et al., 2009; Shade and
Siegel, 2008).
11
In general, we ?nd that the less the downside risk involved in ?ling bankruptcy, the more new?rms are founded.
For policymakers, we suggest that making bankruptcy laws more entrepreneur-friendly will positively affect entrepreneurship
development by lowering exit barriers and entry barriers. For entrepreneurs starting up new ?rms, our advice is that they pay
attention to the nuances of bankruptcy laws in their jurisdiction and that if possible they set up ?rms in a jurisdiction that has
entrepreneur-friendly bankruptcy laws. Although management and entrepreneurship research rarely engages in public policy
issues (as critiqued by Barney, 2005; Kochan et al., 2009; and Peng et al., 2009), the public policy implications of our research are
clear. Speci?cally, our research draws on and extends the recent advance of an institution-based view of entrepreneurship in the
literature (Peng et al., 2008, 2009, 2010) by shedding considerable light on how speci?c formal institutions–in this case,
bankruptcy laws–matter and thus by contributing to important public policy debates.
Second, we extend the arguments made by Lee et al. (2007) and Peng et al. (2010) that at a societal level, entrepreneur-friendly
bankruptcy laws can lower entry barriers by encouraging entrepreneurs to take more risks and start-up more new ?rms. When
risk-taking is encouraged by more entrepreneur-friendly bankruptcy laws, it can generate a variety of entrepreneurial options at
a societal level by increasing the number of ?rms with high growth potential in a country. This may lead to more entrepreneur-
ship and economic development at a societal level. Thus, we echo Hoetker and Agarwal (2007), Knott and Posen (2005),
McGrath (1999), Lee et al. (2007), and Peng et al. (2010) by arguing that failure, although painful for individual entrepreneurs,
may be good—for the economy.
9
For example, in Japan, where stigma of failure is very high, it is well-known that bankrupt entrepreneurs often commit suicide (Time, 1999). About 30 people
commit suicide per day for economic reasons in Japan (Takahashi, 2003).
10
Results are not shown here but are available upon request.
11
This point is underscored by the fact that an earlier version of this article received the U.S. Small Business Administration Best Paper Award for a Babson
Conference paper “exploring the importance of small businesses to the U.S. economy and public policy issues of importance to the entrepreneurial community”
at the 2008 Babson Conference.
Table 4
Signi?cant marginal effects of variables on the rate of new ?rm entry.
Variables Estimated marginal effect
Control variables
GDP per capita ?.087
Number of banks per capita .100
Start-up cost .100
Main variables
Closing time ( Hypothesis 1) .100
Closing cost ( Hypothesis 2) .113
Fresh start ( Hypothesis 3) .113
Automatic stay of assets ( Hypothesis 4b) ?.084
516 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
Third, we empirically substantiate our argument through a longitudinal, cross-country database covering 29 countries on ?ve
continents and spanning 19 years. Our ?ndings, based on corporate bankruptcy laws, converge with those reported by Armour and
Cumming (2008), who focus on personal bankruptcy laws in 15 countries on two continents. Speci?cally, we ?nd that the less time
and less cost associated with the bankruptcy procedure encourages more new ?rm entries. For example, on average ?rms spend
approximately 29 months going through the bankruptcy proceedings. Decreasing this agonizing period to 10 days can boost the
likelihood of new ?rm entry by 10%. It is the same with the cost of bankruptcy. When less can be spent in the bankruptcy
proceeding, this means increased new?rmentry as well. We also ?nd that providing a failed entrepreneur with a fresher start will
encourage higher likelihood of new entry.
It is puzzling that allowing an automatic stay of assets actually dampens the entry of new ?rms. Also, enabling managers to
keep their positions in bankrupt ?rms does not necessarily have a signi?cant impact on new?rm entry. Our ?ndings suggest that
there may be important adverse selection issues associated with keeping a failing ?rm's managers in place—the managers who are
associated with an entrepreneurial ?rm's ?nancial distress may not always be the best managers to continue to manage a ?rm
(Bebchuk, 2002).
The signi?cant results of some of our control variables are noteworthy. We ?nd that the degree of a country's previous economic
development such as GDP per capita, ?nancing infrastructure such as the number of banks per capita, as well as ?nancial barrier to
entry such as start-up cost indeed affect the rate of new ?rm entry within a country (Table 3). The marginal effects of the control
variables (Table 4) showthe magnitude of their effect onnew?rmentry rate. Interms of GDPper capita, a difference of approximately
$12,000 translates to an 8% likelihood of new ?rm entry. The establishment of approximately 1.3 banks (per 1 million population)
means 10% more new ?rm entry likelihood than 0.3 banks (per 1 million population). When it comes to start-up cost, a difference
between a 10.43% and 20.65% of GNI per capita to register a ?rm translates into a 10% change in new ?rm entry likelihood.
Finally, it is important to highlight the similarities in the letter and spirit of personal and corporate bankruptcy laws, although
as noted earlier in this article we choose not to deal with personal bankruptcy laws. For example, the concepts of “fresh start” and
“automatic stay” in corporate bankruptcy laws are similar to “discharge” and “exemptions,” respectively, in personal bankruptcy
laws (Armour and Cumming, 2008). However, many entrepreneurs choose to incorporate their ?rms in order to protect their
personal assets, in case their ?rms go under. Therefore, our ?ndings, from a corporate bankruptcy law perspective, complement
and strengthen Armour and Cumming's (2008) ?ndings that originate from a personal bankruptcy law perspective. In other
words, our study starts to ?ll an important missing gap in the previous literature in terms of how entrepreneur-friendly corporate
bankruptcy laws facilitate more entrepreneurship at a societal level.
7.2. Limitations and future research
Among limitations, our analysis does not incorporate time-varying bankruptcy variables. In other words, we are not able to
account for the changes in corporate bankruptcy laws during the time period in the countries that are covered. While we can take
account of measures such as origin of law and rule of law (La Porta et al., 1997), we are unable to capture the various levels of
development of bankruptcy laws among the countries over time. This is an important limitation that future research may need to
overcome.
Since the Doing Business Report (World Bank) is not a direct measure of outcomes and is, instead, derived from surveys
administered through local experts (e.g., lawyers, consultants, and of?cials), one may also question the consistency of results
across countries. However, the survey is designed with academic advisors, routinely administered through more than 6000 local
experts, and subject to numerous tests for robustness. Data are collected in a highly standardized way to ensure comparability
across economies and over time. This methodology actually offers several advantages including its transparency, allowing multiple
interactions with local respondents to clarify potential misinterpretations of questions.
In a broader sense, we have examined mainly the regulatory, thereby formal, aspects of the institutional environment and their
effect on new ?rm entry. While we have used an important informal aspect of the institutional environment as a control variable
(uncertainty avoidance), it may be interesting to explore the interaction and/or moderating effects of this and other informal
aspects of a country's institutional environment (Peng et al., 2008, 2009). In the case of default, informal workouts are often
undertaken instead of formal insolvency proceedings. In future work, it will be important to examine how formal and informal
constraints can be integrated to create a more coherent understanding of how institutions constrain or facilitate entrepreneurial
activities in different countries.
Also, as suggested in Kaufmann et al. (2007) and Lee et al. (2007), many entrepreneurs may not investigate the nuances of
bankruptcy laws before starting up new businesses. Thus, the ex ante effects of bankruptcy laws on entrepreneurial entry may not
be as strong as suggested by our theory. However, if this is the case, then the results presented here are quite conservative in
nature. Past research on U.S. ?rms, however, shows that there is a signi?cant difference in new?rm formation depending on how
lenient the bankruptcy laws are in different states (Fan and White, 2003). Nevertheless, since similar cross-regional studies within
the same country have not been done on countries other than the United States, where institutions are well developed, it is
worthwhile to examine the relationship in other countries (Davidsson and Wiklund, 1995). It is possible that when other
institutions are more developed, entrepreneurs may become more sensitive to bankruptcy laws. On the other hand,
underdevelopment of other essential institutions such as ?nancing and legal protection of properties may make entrepreneurs
pay less attention to bankruptcy laws, which may have a limited impact.
For example, when property rights are not well protected, entrepreneurs may not pay enough attention to the terminal stage of
bankruptcy. Just making sure that property rights are protected would be already an overwhelming task for many countries. This
517 S.-H. Lee et al. / Journal of Business Venturing 26 (2011) 505–520
may be the reality in many emerging and developing economies, but the United States was not much different in the early 1800s.
For example, “the Chief Justice of the Supreme Court, Joseph Story, wondered in 1820, whether lawyers would even be able to
settle them [bankruptcies and other property rights disputes]” (De Soto, 2003: 9). Clearly, tremendous entrepreneurial and
economic development in the United States since the early 1800s is not entirely due to certain entrepreneur-friendly bankruptcy
laws. Such bankruptcy laws function in the much larger institutional framework facilitating entrepreneurial and economic
development (North, 1990). Likewise, reforming bankruptcy laws and making them more entrepreneur-friendly should not be
viewed as panacea for countries interested in promoting entrepreneurship development. It is the overall balanced development of
the institutions that spurs entrepreneurship, not a piece-meal type development of certain aspects of institutions.
Furthermore, more systematic research in this area such as emerging economies (EE) versus developed economies (DE), high-
tech versus low-tech industries, small entrepreneurial versus large incumbent ?rms may be worthy of exploration. For example,
while some of our attempts did not achieve convergence due to the limited sample size when it comes to splitting data between EE
and DE (Wright et al., 2005), it would be interesting to see the differential effects on ?rms in DE versus EE (Yamakawa et al., 2008).
In terms of industry variation, a high-tech industry characterized by high uncertainty and high variance may be associated with
lower levels of stigma for failure (Lee et al., 2007). Furthermore, the effect of bankruptcy laws on small entrepreneurial ?rms and
the societal impact of their bankruptcy ?lings can be different from the huge ?nancial impact of corporate bankruptcies of large
incumbent ?rms. The policy implications of bankruptcy laws for these different kinds of bankruptcies may be different, thus
necessitating further in-depth research.
8. Conclusion
Contributing to an institution-based viewof entrepreneurship, we have mapped out howentrepreneur-friendly bankruptcy laws
can stimulate entrepreneurship development around the world. Since “bankruptcy is an occupational hazard for entrepreneurs”
(Economist, 2010: 68), making it less hazardous holds the potential to promote more entrepreneurship. Inconclusion, let us quote the
Economist (2010: 68), which addresses government of?cials desperately searching for ways to promote entrepreneurship and
economic growth in the midst of the worst economic crisis:
Making it easier to close a business may not sound as inviting as announcing yet another “enterprise fund” or “innovation
initiative,” but it is more vital to reviving the world's moribund economy. In the short run, enlightened bankruptcy laws
reduce unemployment by keeping viable companies alive. In the long run they boost rates of entrepreneurship. The best
way to get more people to start businesses is to make it easier to wind them up.
Acknowledgments
We thank Donald Siegel (Editor) and two reviewers for excellent guidance and Livia Markoczy for helpful comments. This work
was supported in part by a National Science Foundation CAREER Grant (SES 0552089). Earlier versions of this article were
presented at the Babson College Entrepreneurship Research Conference (IE Business School, Madrid, Spain, June 2007), Academy
of Management (Philadelphia, August 2007), and Strategic Management Society (San Diego, October 2007). A previous version
received a U.S. Small Business Administration Award for the best Babson Conference paper “exploring the importance of small
businesses to the US economy or a public policy issue of importance to the entrepreneurial community,” presented at the 2008
Babson Conference (University of North Carolina, June 2008) with a press release posted at www.sba.gov/advo/press/08-14.html.
We are grateful to the SBA and to the Best Babson Paper Award Committee (chaired by Andrew Zacharakis) for their
encouragement. All views expressed are those of the authors and not necessarily those of the NSF or the SBA.
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