Essays on Personal Bankruptcy Law and Small Business Financing

Thesis (Ph.D.)--University of Washington, 2016-06

In the first chapter of my dissertation I ask whether and how debtor protection affects aggregate small business credit quantity. Using comprehensive data on the number and amount of small business loans granted by commercial banks, and employing a robust difference-in-difference empirical design utilizing staggered shocks to personal bankruptcy exemptions, I find that increases in debtor protection increase the equilibrium quantity of small business credit in local regions. This finding is statistically significant and robust, despite competing demand and supply effects. I find that an average change in the homestead exemption results in a 1.1% increase in the number of small business loans in a local area (census tract), and a 2.5% increase in the total volume. The increase in quantity is concentrated in areas with presumably higher risk aversion and higher wealth, as predicted by the wealth insurance and collateral channels, respectively, and where local banks are better able to determine borrower type. These findings add depth to previous literature on debtor protection and small business financing that finds a tightening of credit terms, and suggest a greater role of the wealth insurance properties of personal bankruptcy law in determining aggregate small business credit quantity. In the second chapter, I ask how soft information affects the average organizational structure in local banking markets. I utilize the same staggered changes in state-level personal bankruptcy exemptions as exogenous shocks to the primary information frictions facing small business lenders: adverse selection and moral hazard. I find that an average increase in exemptions reduces the average distance between borrowers and lender headquarters, where presumably high-level capital allocation decisions are made, by 2.8-3.7%. I find that this result is weaker where social and cultural factors are likely to lessen the scope for moral hazard. Additionally, I find that areas whose bank branch headquarters are more distantly located experience adverse small business outcomes following exemption increases. These results are consistent with theories of soft information and organizational structure where flatter organizations maintain an information advantage over their hierarchical peers, and suggests that information frictions play a prominent role in shaping the competitive landscape of local markets by reducing competition from outsiders.