Published 18 February 2015

Productive entrepreneurship and insolvency legislature

– a cross-country study

This empirical study investigates the strengths of, and the relationship between, different aspects of insolvency legislation and growth-orientated entrepreneurship. Its overall aim is to build up knowledge about the impact of regulation on business.

It is possible to establish a link between insolvency procedures and entrepreneurship, despite the fact that relatively little research has been carried out in this area. Empirical studies show that less stringent insolvency law has a positive impact on entrepreneurship and business development. The studies also indicate that more lenient insolvency regulations can influence both the quantity and the quality of entrepreneurship by encouraging entrepreneurs to start again, which often leads to the development of successful businesses.

This empirical study is unique. It investigates the strengths of and the relationship between different aspects of insolvency legislation and growth-orientated entrepreneurship in particular. Entrepreneurship is a multifaceted phenomenon and the motives behind it and its growth potential vary depending on the type of entrepreneurship. Some companies do not have the intention to grow or lack the prerequisites to do so. The analysis is based on data from the World Bank Cost of Doing Business index and, in particular, the Resolving Insolvency sub-index, which measures the time, cost and recovery rate for creditors when a company goes bankrupt. It is also based on measurements of entrepreneurship from GEM (Global Entrepreneurship Monitor) and other independent institutes that collect data in a standardised way.

A previous study of Japan by Eberhart, Eesley and Eisenhardt, researchers from Stanford University, indicates greater causality between a reform of insolvency law in Japan and a certain type of entrepreneurship (elite entrepreneurs). However, the current analysis uses data from a large number of countries over time and provides robust measurements of a variety of aspects of value-added entrepreneurship (innovative entrepreneurship, growth-orientated entrepreneurship and opportunity-driven entrepreneurship), which means that the results can more readily be generalised. All three indicators or measurements of insolvency from the World Bank (time, cost and recovery rate) have a negative link with opportunity-driven, high-growth and innovative entrepreneurship, despite the fact that the relative importance of these varies. The cost dimension also has a negative influence on necessity-driven entrepreneurship in OECD countries. This type of entrepreneurship is different in nature and involves individuals being forced to become self-employed in order to earn their living. This is in contrast with opportunity-driven, innovative and growth-orientated entrepreneurship, which are regarded as being more important for OECD countries.

An analysis of the data at a country level shows that more lenient insolvency legislation can reduce the obstacles in the event of a company failing and, therefore, encourage growth-orientated and innovative entrepreneurship. This result supports and reinforces the conclusions drawn by Eberhart et al (2013) in their study of the Japanese reform, which gives the appearance of being a natural experiment. More forgiving insolvency regulations are felt to have the positive consequence of encouraging "better" and not just increased entrepreneurship. Individuals who are considering starting up and working in a company that has the explicit intention of growing or the potential to do so often take into account the consequences of failure when they make their decision.

Therefore, the socio-economic benefit of considering less stringent insolvency regulations is considerable, because the rules have an influence in particular on which individuals start up companies. It is also worth mentioning that, from a growth perspective, the significance of the fact that entrepreneurs can continue actively doing business during a debt rescheduling procedure is very slight. It is much more important for the overall time taken by the bankruptcy and debt rescheduling procedures to be kept to a minimum and for the individual to be given the opportunity to try again and to launch a new company or project.

The proposal from the Public Inquiry (Swedish Government Official Studies, SOU 2014:44) that the length of the payment plan should be three years, combined with the proposal to change the effective procedural regulations, means that the overall time needed for an insolvency procedure will in principle be halved. The proposal also allows certain entrepreneurs who previously were not able to have their debts rescheduled to be offered the opportunity to do so. For these people, the change has an even greater impact, because under the terms of current legislation they cannot have their debts written off after bankruptcy.

Title
Productive entrepreneurship and insolvency legislature – a cross-country study

Serial number
PM 2015:02

Reference number
2014/018

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