A Spatial Model of the Impact of Bankruptcy Law on Entrepreneurship

This paper employs spatial econometrics techniques to estimate the impact of bankruptcy regulation on small firm formation. The estimation of the model is computationally challenging due to the joint appearance of a lagged endogenous variable and the unobserved heterogeneity which requires modelling of initial conditions as described in Heckman (1981). We test for the joint significance of the state dummy variables in a way that can be viewed as an interesting alternative to the Hausman procedure. This was important for our analysis since, as sometimes happens in finite samples, the estimated variance-covariance matrix was not positive semi-definite. We found that the predicted probability of starting a business is 25% higher in states with higher bankruptcy exemptions than their neighbours relative to states with lower exemptions than their neighbours.