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Bankruptcy, Incorporation, and the Nature of Entrepreneurial Risk

Author

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  • Andrew Glover

    (University of Minnesota and Minneapolis Federal Reserve Bank)

Abstract
Entrepreneurship is risky; entrepreneurs forgo wages and invest their time and resources into a business with large potential gains, but uninsurable risks. It is vital to know the extent of these risks, and the insurance available against them, in order to assess corporate tax and personal bankruptcy reforms. We document that incorporated entrepreneurs operate larger businesses, accumulate more wealth, and are on average more productive than unincorporated entrepreneurs. We embed the U.S. bankruptcy and incorporation legal systems in a quantitative macroeconomic theory of occupational, incorporation, and default choices that accounts for the cross-sectional facts. In the model, as in the U.S., incorporation provides insurance via limited liability beyond personal bankruptcy exemptions, at the expense of administrative burdens and an endogenous interest rate premium. Our model suggests that capital shocks are important entrepreneurial risks. A calibrated economy in which each unit of installed capital entails a small probability (0.6%) of a catastrophic shock (full destruction of capital) is able to account for the data along multiple untargeted dimensions. A counterfactual exercise is performed to see if reducing the costs of incorporation can account for an increase in wealth inequality in line with US data.

Suggested Citation

  • Andrew Glover, 2010. "Bankruptcy, Incorporation, and the Nature of Entrepreneurial Risk," 2010 Meeting Papers 1010, Society for Economic Dynamics.
    • Handle: RePEc:red:sed010:1010
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    References listed on IDEAS

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    13. Neus Herranz & Stefan Krasa & Anne P. Villamil, 2017. "Entrepreneurs, legal institutions and firm dynamics," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(1), pages 263-285, January.
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    Cited by:

    1. Joao Galindo da Fonseca, 2022. "Unemployment, Entrepreneurship and Firm Outcomes," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 45, pages 322-338, July.
    2. Fatih Guvenen, 2011. "Macroeconomics with hetereogeneity : a practical guide," Economic Quarterly, Federal Reserve Bank of Richmond, vol. 97(3Q), pages 255-326.
    3. João Galindo da Fonseca & Charles Berubé, 2023. "Spouses, Children, And Entrepreneurship," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 64(3), pages 1165-1199, August.
    4. Youngsoo Jang & Soyoung Lee, 2021. "A Generalized Endogenous Grid Method for Default Risk Models," Staff Working Papers 21-11, Bank of Canada.
    5. Dean Corbae & Pablo D’Erasmo, 2021. "Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics [Does Industry-wide distress Affect Defaulted Firms? Evidence from Creditor Recoveries]," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 88(5), pages 2239-2274.
    6. Kyle Herkenhoff, 2016. "The Impact of Consumer Credit Access on Employment, Earnings and Entrepreneurship," 2016 Meeting Papers 781, Society for Economic Dynamics.
    7. Mariacristina De Nardi, 2015. "Quantitative Models of Wealth Inequality: A Survey," NBER Working Papers 21106, National Bureau of Economic Research, Inc.
    8. Mankart, Jochen & Rodano, Giacomo, 2015. "Personal bankruptcy law, debt portfolios, and entrepreneurship," Journal of Monetary Economics, Elsevier, vol. 76(C), pages 157-172.
    9. Neus Herranz & Stefan Krasa & Anne P. Villamil, 2015. "Entrepreneurs, Risk Aversion, and Dynamic Firms," Journal of Political Economy, University of Chicago Press, vol. 123(5), pages 1133-1176.
    10. Naijia Guo & Charles Ka Yui Leung, 2021. "Do elite colleges matter? The impact on entrepreneurship decisions and career dynamics," Quantitative Economics, Econometric Society, vol. 12(4), pages 1347-1397, November.
    11. Mariacristina De Nardi & Giulio Fella, 2017. "Saving and Wealth Inequality," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 26, pages 280-300, October.
    12. Yongwook Paik, 2013. "The Bankruptcy Reform Act of 2005 and Entrepreneurial Activity," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 22(2), pages 259-280, June.
    13. Akyol, Ahmet & Athreya, Kartik, 2011. "Credit and self-employment," Journal of Economic Dynamics and Control, Elsevier, vol. 35(3), pages 363-385, March.
    14. Neus Herranz & Stefan Krasa & Anne P. Villamil, 2017. "Entrepreneurs, legal institutions and firm dynamics," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 63(1), pages 263-285, January.

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