Corporate Bankruptcy without Limited Liability

Abstract

We evaluate the impact of corporate bankruptcy on small business owners. Unlike large firms, we show the majority of small business owners void limited liability protections by providing personal collateral or personally guaranteeing corporate debt; as a result, corporate bankruptcy is frequently followed by either filing personal bankruptcy, or personal debt delinquency, collections, and foreclosure. However, these outcomes are highly dependent on whether the owner can successfully reorganize the corporate debt. Exploiting the assignment of judges to bankruptcy court, we find that relative to corporate reorganization, liquidation increases the rate of personal bankruptcy by 18 percentage-points among owners with guarantees (with no additional effects on owners without guarantees). Our results verify the primary benefit of reorganization for small business owners and provide implications for the design of policies aimed at encouraging access to corporate debt relief.