Personal Bankruptcy Costs

Their Relevance and Some Estimates

Abstract

The paper argues that there is a need for the formal treatment of personal bankruptcy costs in thefinance literature. The need arises out of the relevance of such costs to both corporate and personal financing decisions. We show that (a) personal bankruptcy costs (like personal taxes) are relevant to the corporate capital structure problem and that (b) differential bankruptcy costs across corporations and individuals can result in a clientele model of individual investment-borrowing decision which could lead to insti- tutional arrangements designed to minimize combined bankruptcy costs. Further, we develop a theory ofpersonal bankruptcy and a set of testable hypothesis with regard to their costs. Some preliminary estimates of personal bankruptcy costs are reported which suggest that they are higher than corporate bankruptcy costs. There is also some evidence of economics of scale in personal bankruptcy costs.