Failure Is an Option: Failure Barriers and New Firm Performance

Abstract

Do bankruptcy changes in the institutional environment affect the rate of founding by particular types of founders and the performance of their ventures? We take advantage of a natural experiment in Japan where during the last decade Japan implemented legal reforms to revive Japan's economic fortunes by changes to bankruptcy laws that reduced the consequences of closing a firm. We argue that lowered costs of exit may have attracted individuals with greater human capital and social networks thus positively affecting new firm performance. We argue and test whether making it easier to fail will attract more founders and higher human capital founders resulting in improved firm performance. Our findings are: a) as expected the bankruptcy rate increases but at a higher rate for high human capital individuals, b) the rate of startup firms increases for older and elite educated entrepreneurs, and c) these groups of entrepreneurs are more likely to found higher performing firms. Overall, while prior research emphasizes the lowering of entry barriers, our work shows that reducing the costs of failure can also stimulate venture formation among certain groups, and lead to forming higher performing firms.

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