US Bank Regulators Could Have Averted $9 Billion in Losses
An analysis of the 2023 bank failures assesses their hits and misses.
US Bank Regulators Could Have Averted $9 Billion in Losses
Dan Page
The ability to declare bankruptcy is a right enshrined in the US Constitution. Countless giant corporations (American Airlines, Apple, Chrysler, and General Motors among them) have used court protection against creditor lawsuits under Chapter 11 of federal bankruptcy law to reorganize their affairs and continue in business. Former president Donald Trump’s enterprises have used bankruptcy filings at least six times.
And yet, the small businesses that account for more than 40 percent of the US economy rarely utilize Chapter 11 bankruptcy, according to Harvard’s Shai Bernstein, Chicago Booth’s Emanuele Colonnelli, University of Toronto’s Mitchell Hoffman, and Brigham Young’s Benjamin Iverson. Instead, they tend to struggle with debt until they have no choice but liquidation.
Through an experiment involving about 1,400 small businesses, the researchers find that the owners were often unaware of the benefits of Chapter 11 debt restructuring. Those who did understand it tended to resist the process because of the stigma and the legal costs. Elevating awareness and addressing stigma around Chapter 11 are unlikely to change the situation, the study suggests.
The researchers worked with SCORE, a mentorship organization, to reach a representative sample of US small businesses. They then split the business owners into three groups. A control group watched a short video about a hypothetical small business that was struggling financially. A second group watched an informational video that discussed differences between Chapters 7 and 11 and explained how the 2019 Small Business Reorganization Act makes bankruptcy less expensive. A third group viewed the informational video and also watched a clip designed to reduce the fear of stigma associated with bankruptcy.
These relatively small interventions bore sizable results. In the control group, only 34 percent of small-business owners were familiar with the differences between Chapters 7 and 11; only 9 percent were aware that the SBRA makes filing for bankruptcy easier; and 70 percent agreed with the statement “People will think that a business owner who files for bankruptcy is a failure.”
Owners lacked information
In comparison, business owners who watched the informational video were 45 percentage points more likely to understand Chapter 11 and 65 percentage points more aware of the SBRA. Similarly, those who watched the additional video about stigma were far less concerned about negative connotations associated with filing for bankruptcy. Though slightly weakened, these findings held up in a survey the researchers conducted with the same businesses four months later. Owners in these groups also professed a greater willingness to take on debt, consider Chapter 11, and assume risk.
However, when it came to actual behavior, the researchers find no difference among companies across the three experimental groups. Four months after the initial experiment, businesses that reported more awareness of and less fear of stigma around Chapter 11 were neither more successful nor more likely to have filed for bankruptcy than companies in the control group.
“These longer-run results, therefore, paint a picture in which information and stigma frictions can meaningfully and durably be reduced, but where the alleviation of these constraints does not have detectable effects on firms’ use of bankruptcy or on other related real business outcomes,” the researchers write.
In search of an explanation, Bernstein, Colonnelli, Hoffman, and Iverson surveyed 129 judges and attorneys who belong to the American Bankruptcy Institute, asking why more informational awareness and less fear of stigma didn’t lead to different outcomes. The respondents overwhelmingly pointed to entrepreneurial overconfidence, also indicating that the expense of declaring bankruptcy may also be a concern, although a less important one.
Entrepreneurs with negative or ill-informed views of bankruptcy are likely wait until the bitter end before considering it—introducing delays that could make the process too costly, the researchers conclude.
For that reason, simply making Chapter 11 less expensive, as the SBRA does, won’t do much to push more small businesses to use it strategically, according to the research. Rather, policy makers should start with education and stigma-reduction efforts to ensure that bankruptcy reorganization is a path that companies are willing to consider.
Shai Bernstein, Emanuele Colonnelli, Mitchell Hoffman, and Benjamin Iverson, “Life after Death: A Field Experiment with Small Businesses on Information Frictions, Stigma, and Bankruptcy,” Working paper, May 2023.
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