Creating

CLOSING A BUSINESS 71
Such measures discourage the use of bankruptcy.
And they dampen entrepreneurship: studies in the
United States show that entrepreneurs try several business
ideas before succeeding. Punishing fraud is justified,
but bankruptcy is different. An entrepreneur can
have bad luck or make mistakes. Bankrupt debtors face
stigma anyway. Why compound it with legal penalties?
Reforming such penalty provisions in bankruptcy
laws has been popular. Madagascar’s new law separates
management sanction from liquidation. Previously they
were one and the same, whether or not there was fraud.
Thailand’s 2004 reform distinguishes fraudulent bankrupts
from those in good faith. In Poland before 2003,
bankrupt entrepreneurs were automatically banned
from getting a fresh start for 5 years. Now it could be for
3–10 years, but only if the court decides the case involves
fraud. The United Kingdom’s Enterprise Act of 2002 removed
automatic penalties on bankrupt debtors.
Why reform?
Bottlenecks in bankruptcy cut the amount that claimants
can recover. 4 In countries where bankruptcy is
used, this is a strong deterrent to investment. Access to
credit shrinks. And nonperforming loans and financial
risk rise because creditors cannot recover overdue loans
(figure 11.6). Even in poor countries, where bankruptcy
is rarely used, efficient laws can serve as a threat and encourage
debtors to negotiate and restructure outside of
bankruptcy. In Egypt an estimated 95% of bankruptcy
filings are made to speed informal workouts and enforcement.
5
Easier exit means easier entry. Bankruptcy laws can
also encourage entrepreneurs. One study shows that
reforms to encourage a fresh start have raised rates of
entrepreneurship by 8–9%. 6 The freedom to fail, and to
do so through an efficient process, puts people and capital
to its most effective use. The result is more productive
businesses, and more jobs.
Notes
1. Gazeta Mercantil (Brazil), “New Bankruptcy Law Could
Inject R$204 bn,” June 2, 2005.
2. Azar and Lu (2004).
3. Couwenberg (2001).
4. World Bank (2004a) and Franks and Loranth (2005).
5. Data from Doing Business local partners.
6. Armour and Cumming (2005).