Credit and self-employment

The US personal bankruptcy system allows debtors to discharge uncollateralized debts if they give up assets in excess of a threshold known as an “exemption”. However, since exemptions erode repayment incentives, they may increase borrowing costs. Our paper evaluates the tradeoff between credit costs and the insurance against failure created by bankruptcy exemptions. We find that exemptions change self-employment rates and the timing, size, and financing of projects. We also find that the positive relationship between wealth and self-employment rates may not arise from credit constraints: such a relationship is present even when credit is plentiful at low interest rates.