Policymakers strive to create legislation that promotes entrepreneurship, as it influences individuals’ propensity to start new ventures. While research extensively covers the effects of tax and interest policies on entrepreneurship, the impact of insolvency laws remains underexplored in law and economics scholarship. In our paper entitled “The flip side of the coin: how entrepreneurship‑oriented insolvency laws can complicate access to debt financing for growth firms”, we examine the changes in the use of debt for growth firms, using the recent reform of Belgian insolvency and company law in the 2017-2019 period as an exogenous policy shock (e.g. easier access to debt remission for natural persons, the new rule for demarcation of the assets of the bankrupt estate from art. XX.110, §3 and the ‘cheaper’ form of limited liability due to the introduction of the BV without a legal [minimum] capital).
What research tells us, and doesn’t tell us
The overall objective of the change towards a more debtor-friendly insolvency law is mainly to foster entrepreneurship. Several cross-country studies have found a positive association between a more debtor-friendly insolvency law and entrepreneurship by studying the change in self-employment or firm-formation rates (Armour & Cumming, 2008; Fan & White, 2003; Lee, Lee, Yamakawa, & Yamakawa, 2012; Lee, Yamakawa, Peng, & Barney, 2011). In addition, some single-country studies have shown that changes towards a more debtor-friendly insolvency law positively impact an individual’s decision to start or restart (e.g., after a bankruptcy) a business (Dewaelheyns & Hulle, 2008).
However, the change in law will not only affect debtors (entrepreneurs) but also influences the behaviour of creditors. When the law moves towards a debtor-friendly approach, it shifts the legal landscape in a way that creditors may find less favourable. This change increases the risk for creditors, as they may have difficulties recovering debts in case of debtor bankruptcy. The debtor-friendly law introduces measures that offer more protection and relief to debtors, making it easier for them to restructure, settle, or even get debt forgiveness. Consequently, creditors may struggle to fully recover their debts, leading to increased caution when extending credit to entrepreneurs under such debtor-friendly insolvency rules (Berkowitz & White, 2002; Fossen, 2014; Hirose, 2009; Lee et al., 2012).
The increased risk and reduced recovery prospects can result in creditors becoming more cautious when extending credit to entrepreneurs operating within the debtor-friendly insolvency framework. This argumentation is supported by, among others, the results of the cross-country study of Lee et al. (2012) and the German study of Fossen (2014), which examined the impact of a more forgiving personal bankruptcy law, that allows for a ‘fresh start’, on both debtors and creditors. On the one hand, it was found that the law made entrepreneurship more attractive, as entrepreneurs do not risk losing as much wealth and future income in the case of bankruptcy. On the other hand, financial institutions were found to become more risk-averse towards entrepreneurs because the entrepreneurial risk is shifted to the creditors, who, in the event of the debtor’s bankruptcy, become less likely to collect their debt.
Based on the existing literature and its absence, two key questions must be considered to thoroughly assess the effectiveness of the new Belgian insolvency law:
How does the change towards a more debtor-friendly insolvency law affects the debt financing of Belgian growth firms? (We focus on 25 284 Belgian growth firms since, given the higher perceived riskiness of these firms, it is likely that growth firms will mainly have to bear the consequences of stricter creditors after the law change.)
Will every creditor adjust their behaviour in the same way after the law change? ( In general, there are four main groups of creditors: banks, trade creditors, employees (e.g., unpaid wages), and the government (e.g., unpaid taxes) (Baugnet & Zachary, 2007). It is rather unlikely that the government and employees will finance growth since there is little room for negotiation to increase these debt levels. Therefore, to finance growth, a firm will most likely go to banks and trade creditors.)
The reaction of banks to the law change
Based on the Law and Economics literature, banks are called “adjusting creditors”. As argued by Armour (2006), these creditors possess the resources, expertise, and bargaining power to manage and mitigate default risks through transaction costs. Banks are typically well-capitalized, have the capacity to enforce stringent lending practices, maintain legal departments that stay abreast of legal developments, and can conduct thorough risk assessments for their extensive customer base. Furthermore, the hierarchy established by bankruptcy laws prioritizes certain creditors, such as employees and tax authorities, over unsecured creditors like banks. Given this hierarchy, banks tend to be more risk-averse when extending credit, particularly to risky growth firms (Rostamkalaei & Freel, 2016). Taking into account the new insolvency law, we expect financial institutions to be more adjusting, and thus more reluctant in providing debt financing to growth firms after the change towards a more debtor-friendly insolvency law.
Our results confirm the above expectation and indicate that higher growth firms experience difficulties in obtaining credit from financial institutions after the law change.
The reaction of trade creditors to the law change
According to the Law and Economics literature, trade creditors are often referred to as “non-adjusting creditors.” They typically do not alter the terms of credit extended to debtors based on the debtor’s riskiness, as banks do (Armour & Cumming, 2008). Trade creditors may lack the necessary resources, bargaining power, and expertise to act in a strict and risk-averse manner. Their smaller scale of operation makes it less justifiable for them to incur significant transaction costs, and they may not enjoy the same economies of scale as banks. Trade creditors also have the advantage of strong transactional relationships and private information about their customers, reducing their credit risk. Therefore, they are less likely to change credit terms, especially when these terms are institutionalized within a specific sector (Baugnet & Zachary, 2007; Uchida, Udell, & Watanabe, 2013).
In light of these differences, we expect that growth firms will find it easier to obtain financing from trade creditors than banks after the shift to a more debtor-friendly insolvency law. In other words, due to the less adjusting nature of trade creditors compared to financial institutions, growth firms are likely to partially substitute financial debt with trade credit after the law change.
However, our results show that after the introduction of a more debtor-friendly insolvency law, trade creditors have also become stricter towards higher growth firms after the law change.
Have growth firms taken on more debt from other creditors?
Our results show that both financial institutions and trade creditors have become more strict towards growth firms after the change towards a more debtor-friendly insolvency law. Therefore, an important question to ask next is whether growth firms have taken on more debt from other creditors. To examine this, we looked at the residual category, being the government and employees. The results of this analysis indicate a dangerous situation, namely that growth firms are delaying paying their taxes and personnel costs, and so in this way ‘force’ financing from the government and employees because they do not obtain enough funding from banks and trade creditors.
What can we learn from these results?
The economic implications of a shift towards a more debtor-friendly insolvency law that limits the debt financing of growth firms can have significant consequences for the future orientation of bankruptcy reforms. Such changes can impact the availability of debt financing for firms, especially those seeking to finance their growth initiatives. This, in turn, may influence the investment decisions, entrepreneurial activities, and overall economic development of a country. Belgium’s experience is not unique, as other countries, like the United States and Germany, have implemented similar pro-debtor changes, with growing relevance to other European countries considering such adjustments.
The economic analysis of these pro-debtor changes underscores the need to consider both positive and negative effects. While a debtor-friendly insolvency law may offer struggling firms opportunities for restructuring and job preservation, it may also restrict debt financing for growth firms, potentially hindering entrepreneurship, innovation, and investment. The experiences in Belgium can guide broader discussions on achieving the right balance between debtor protection and access to debt financing for growth firms, ensuring effective and sustainable bankruptcy regimes that support economic growth and resilience.
The full paper, co-authored with Nadine Lybaert, Maarten Corten and Tensie Steijvers, can be consulted here.
Maren Forier
Niels Appermont
References:
Armour, J. (2006). Legal capital: an outdated concept? European Business Organization Law Review (EBOR), 7(1), 5-27.
Armour, J., & Cumming, D. (2008). Bankruptcy law and entrepreneurship. American Law and Economics Review, 10(2), 303-350.
Baugnet, V., & Zachary, M. (2007). De financiering van de Belgische ondernemingen in Europees perspectief.
Berkowitz, J., & White, M. J. (2002). Bankruptcy and small firms’ access to credit (0898-2937).
Dewaelheyns, N., & Hulle, C. V. (2008). Legal reform and aggregate small and micro business bankruptcy rates: evidence from the 1997 Belgian bankruptcy code. Small Business Economics, 31(4), 409-424.
Fan, W., & White, Michelle J. (2003). Personal Bankruptcy and the Level of Entrepreneurial Activity. The Journal of law & economics, 46(2), 543-567.
Fossen, F. M. (2014). Personal Bankruptcy Law, Wealth, and Entrepreneurship—Evidence from the Introduction of a “Fresh Start” Policy. American Law and Economics Review, 16(1), 269-312.
Hirose, S. (2009). Effects of the Bankruptcy Laws Reform on Banks: The examination of recent Japanese experience. Public Policy Rev, 5(2), 201-228.
Lee, S.-H., Lee, S.-H., Yamakawa, Y., & Yamakawa, Y. (2012). Forgiving Features for Failed Entrepreneurs vs. Cost of Financing inBankruptcies. Management International Review, 52(1), 49-79.
Lee, S.-H., Yamakawa, Y., Peng, M. W., & Barney, J. B. (2011). How do bankruptcy laws affect entrepreneurship development around the world? Journal of Business Venturing, 26(5), 505-520.
Rostamkalaei, A., & Freel, M. (2016). The cost of growth: small firms and the pricing of bank loans. Small Business Economics, 46(2), 255-272.
Uchida, H., Udell, G. F., & Watanabe, W. (2013). Are trade creditors relationship lenders? Japan and the World Economy, 25, 24-38.
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