The Financial Benefits of Bankruptcy - Credit Slips

Earlier this week I wrote about the extensive data that have been made available to me by the Canadian bankruptcy regulator, the Office of the Superintendent of Bankruptcy (OSB). The main element of the database is the balance sheet from every electronically filed consumer bankruptcy in Canada from 2005 to 2010.

One of the first things we (my PhD Student Vyacheslav Mikhed and I) have tried to do with this data is to measure the Financial Benefits of Bankruptcy (FBB) as reflected in the individual filer?s balance sheet.

The idea of FBB is taken from the paper of Fay, Hurst and White (American Economic Review, 2002, specifically page 708) and is simply the idea of measuring how much the bankruptcy filer gains through the discharge of unsecured debt minus the non-exempt assets the filer loses in bankruptcy. The larger the gains through unsecured debt discharged and the smaller the loss of non-exempt assets, the larger will be the financial benefits of bankruptcy to each individual filer.

Our aim is to figure out what this number looks like across the almost 400 thousand bankruptcy filings in our database. When Fay, Hurst and White (2002) calculated FBB, they were only able to use 254 bankruptcy balance sheets (taken from PSID data). To the best of our knowledge, no other authors have calculated FBB, and certainly not with a database as large as ours.

Our measure of FBB across all Canadian bankruptcy filers looks like this:

What is most interesting about this picture is the very wide dispersion of FBB across Canadian filers. FBB can be close to zero for some filers and higher than $100 000 for other filers. We think explaining this picture is very important for understanding when and why individuals file for personal bankruptcy. Why do some filers file when their FBB is low, while others file when the FBB is much higher?

We think that an important part of the story is that FBB only captures what is on the balance sheet of the individual filer on the day of the filing, it does not capture a whole variety of other possible factors that go into the bankruptcy decision that are not reflected on the balance sheet ? which we label non-balance sheet factors.

For example, the literature has emphasized the importance of social stigma when filing, which cannot be reflected in a simple balance sheet calculation. Similarly, the literature has also emphasized the importance of forward looking behavior when making the bankruptcy filing decision ? for example, how will my bankruptcy today impact my future access to jobs, credit etc. The balance sheet reflects the situation of the filer at the date of filing, and does not reflect forward looking behavior.

What could possibly be happening in the FBB figure above is that the individual will file when the financial benefits of bankruptcy (as measured by the balance sheet data in the figure) exceed the various non-balance sheet costs such as social stigma and fears about future access to credit and employment etc.

For example, an individual with higher stigma related costs of bankruptcy will require higher financial benefits from bankruptcy in order to overcome those stigma related costs and be persuaded to file.

The aim of our ongoing research agenda is to try to test these hypotheses.

Source: http://www.creditslips.org/creditslips/2012/10/the-financial-benefits-of-bankruptcy.html

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