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Small Business Economics

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01.12.2008

Legal reform and aggregate small and micro business bankruptcy rates: evidence from the 1997 Belgian bankruptcy code

verfasst von: Nico Dewaelheyns, Cynthia Van Hulle

Erschienen in: Small Business Economics | Ausgabe 4/2008

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Abstract

Many Continental European countries recently reformed their bankruptcy legislations to stimulate reorganization and firm survival. We show that the Belgian 1997 bankruptcy code reform, which implemented several international best practice recommendations, significantly reduced aggregate small and micro business bankruptcy rates. However, using distributed lag models to control for the relationship between bankruptcy rates and macroeconomic variables such as real GDP growth, consumer confidence, inflation, etc., we find that the new code’s impact is not the same for all types of companies. Specifically, while the beneficial effect of the reform is largely similar between small firms (i.e. stock corporations) and micro firms (i.e. partnerships), it is only significant in certain industries (manufacturing and trade). Overall, our results indicate that especially the measures taken to limit domino bankruptcy effects are likely to have had a substantial impact. Our findings have several policy implications for the evaluation and modification of the bankruptcy system.

Vorheriger Artikel The impact of foreign direct investment on new firm survival in the UK: evidence for static versus dynamic industries

Nächster Artikel Expectations, network effects and timing of technology adoption: some empirical evidence from a sample of SMEs in Italy

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One could argue that a major goal of any bankruptcy system should be procedural efficiency. In this sense, a perfect bankruptcy system should strive for perfect filtering between viable companies which should be allowed to reorganize and non-viable companies which should be liquidated as soon as possible to reallocate its resources to a more profitable use (cf. White 1994). Nevertheless, reforms (including the Belgian one) often include many measures which are meant to prevent companies from ending up in the bankruptcy system at all. This means that if the key features of the reform function well, this should, ceteris paribus, be reflected by a decrease of the aggregate bankruptcy rate.

This is a direct result of the importance of small businesses in the European economy: SMEs represent 99.8% of all companies (estimate for the European economic area + Switzerland; Source: European Commission 2003 Observatory of European SMEs). The EU’s criteria for SME classification valid until Jan 1st, 2005 were: Micro: less than 10 employees (after Jan 1st, 2005: less than 10 employees, net income <2 million EUR, total assets <2 million EUR). Small: less than 50 employees, turnover <7 million EUR, total assets <5 million EUR (after Jan 1st, 2005: less than 50 employees, turnover <10 million EUR, total assets <10 million EUR). Medium: less than 250 employees, turnover <40 million EUR, total assets <27 million EUR (after Jan 1st, 2005: less than 250 employees, turnover <50 million EUR, total assets <43 million EUR).

See Altman and Narayanan (1997) for an extensive international survey on corporate failure prediction models.

The bankruptcy law of August 8, 1997 and the law on the reorganization procedure of July 17, 1997. Both came into effect on January 1, 1998 and will be referred to as the ‘code’ in the remainder of the paper. Some minor legal-technical issues were solved by the law of September 4, 2002 (effective as of October 1, 2002).

Formally, a reorganization code existed since 1887, and was updated in 1946. However this reorganization procedure had been in disuse for decades.

Note that this part of the reform has in principle also entailed a reduction in the protection of privileged claimants (including e.g. mortgage holding banks, which are very important in Belgium’s bank-based financial system). Specifically, the stay on the execution of privileges has been strengthened and a reorganization plan may be confirmed even if a privileged debt holder objects. In practice, these reductions of secured creditor rights are quite limited though and unlikely to significantly affect the latter’s debt providing behavior.

Other changes comprise new procedures allowing for a quick start-up of a new company that continues all or part of the economic activities of the failed firm. In practice there prove to be many problems with the practical implementation of these new procedures and they are rarely used.

The role of secured creditors in the 1997 Reorganization Procedure is very important. Although they have no formal veto right against a reorganization plan, their approval is essential because secured creditors who do not approve the plan are not bound by its terms. This means that once the court protection period is over, these secured creditors can execute their claims in full, thus again jeopardizing the survival chances of the firm. Therefore, reorganization plans that are not supported by one or more of the major secured creditors are almost never confirmed by the court.

It should be noted that not including the formal reorganizations in the BR variables could influence our analysis if a substantial number of failing companies in the post-reform period would opt for such a procedure. However, few small businesses make this choice. According to the NBB database, only 382 small business reorganization procedures were initiated during our sample period (1998–2002), compared to 20,589 liquidation procedures. This means that the so-called ‘reorganization rat’ (i.e. the proportion of started reorganization procedures to the sum of all initiated procedures) equals only 1.82%. By comparison, for companies which Belgian accounting law classifies as ‘large’ (and which are not included in this study), 97 reorganization cases were opened during the same period, compared to 528 liquidation cases (i.e. a reorganization rate of 15.52%). Not surprisingly all results are robust for adjustment of the definition of the bankruptcy rate to include both liquidation and reorganization.

The current version of the corporate event database available to us does not allow us to extend the sample period beyond 2002. However, as a robustness check, we have constructed alternative bankruptcy rate and birth rate series from statistics on stock corporations compiled by private data provider Graydon Belgium. Note that these series do not make a distinction between large and small companies, nor between different industries, but do allow extending the sample period up to 2006. Main results remain unchanged.

Company level accounting data—including size information—is collected in the BelFirst accounting database, which contains highly detailed company level information but is not designed as a research database. One of the consequences of this fact is that records of companies that are no longer active (e.g. bankruptcies, mergers & acquisitions, voluntary liquidations, etc.) are completely deleted from the database after about 2 years (i.e. from the point of view of the database it looks as if they never existed). The missing data can be retrieved by using older versions of the database, but only back to the mid 1990s.

To sell shares in a partnership, the authorization of at least half of the other partners (representing at least 75% of shares) is required.

Data for fiscal year 2004, based on financial statements of more than 81,000 stock corporations and 171,000 partnerships.

Using the 2 million euro total assets criterion recently set by the European Commission as an upper limit for micro companies, 68.4% of all micro companies would be partnerships and 81.1% of all small companies would be stock corporations. Applying a stricter cut-off value of 1 million euros in total assets as the boundary between small and micro business, implies that 72.0% of all micro companies would be partnerships and 74.3% of all small companies would be stock corporations.

This split is only used to improve the informational content of the univariate statistics and plays no role in the time series analysis of Sect. 4.

Note that, for brevity, only the overall birth rate is reported in Table 3. The birth rates for the different legal forms and industry groups show a similar downward trend. Part of this negative trend is due to the definition of the corporate birth rate as the number of new companies divided by the number of existing companies (which steadily increases through time). As all models are estimated in differences, this does not affect regression results.

Augmented Dickey-Fuller test results for all variables available upon request. An alternative estimation method would be the use of cointegration analysis and vector error correction models (cf. Liu and Wilson 2002). However, the relatively limited length of the time series could result in robustness issues.

Cross-correlograms available upon request.

In general, a lag length of 8 periods and polynomials of order 3 result in the best fit.

Individual lag results are available upon request.

Note that the fact that the sum of lag term coefficients is significant does not necessarily mean that all coefficients for individual lags are significant. Vice versa, individual lag terms can be significant even if the sum of lag terms is not.

As a robustness check, we also consider several interest rates: the average rate on long term (>4 years) corporate investment loans at the Société Nationale de Crédit à l’Industrie, the yield on long term government bonds (>8 years), the interest rate on 3 month treasury certificates and the real interest rate on 3 month treasury certificates. We find that the link between these interest rates and the total small and micro business bankruptcy rates is quite weak compared to the other macroeconomic series used in Table 4. Only the long run relationship with the nominal 3 month treasury yield is significant at the 10% level, although this appears to be largely due to its inflation component. The Chow breakpoint tests all indicate a structural break in the first quarter of 1998 and the CODE dummy is highly significant for all four models.

This partial structural break specification (i.e. allowing for a change in the intercept and assuming the other coefficients remained stable after the break) is the approach usually followed in the literature (see for instance Vlieghe 2001; Liu and Wilson 2002 or Liu 2004). The alternative is a pure structural break model, which has the advantage that it allows for all coefficients to change, but has the drawback of being very costly in terms of degrees of freedom. As a robustness check, we estimated pure structural break specifications for all models in the right-hand side of Table 4. Only the model for INFL shows a highly significant difference in PDL coefficients before and after the break. This is likely to be the explanation for the lack of significance of the sum of the lagged coefficients for ΔINFL in Table 4. More importantly, the CODE dummy remains significant in 6 out of 7 models.

To give an idea of the impact in real terms, the median coefficient for the CODE dummy of −0.0355 corresponds to a decrease in the number of bankruptcies with 86.8 per quarter in the post reform period (i.e. an average reduction of 8.4% in the number of liquidation type bankruptcies).

Available upon request.

The same picture arises when univariate models (similar to those in Table 4) are estimated for each legal type separately (not reported). The Chow breakpoint tests point to a structural break in all stock corporation models and six out of seven partnership models. Moreover, the CODE dummy’s coefficients systematically indicate a slightly stronger impact for stock corporations. The differences with the corresponding partnership models are not statistically significant though.

Models using only one lag structure (not reported) show that the sum of lag coefficients for corporate birth rates would even be significantly positive in the case of partnerships. For both legal forms, the short term lags (up to three or four quarters) are negative and the longer term lags are positive, but their relative importance differs.

As for panel A of Table 5, models that optimize fit were estimated as well. This also allows for the fact that a macroeconomic series may better explain the bankruptcy rates for one industry than for others. Results for the CODE dummies are consistent with those reported here.

This split also corrects for possible problems in comparability of findings between stock corporations and partnerships due to differences in industry composition of these two firm types.

To transform the annual aggregate financial statement data into quarterly series we assume that the values change in a linear way throughout the year (for instance, the value for 2000Q2 is the average of the values of 1999Q4 and 2000Q4, the value for 2000Q1 is the average of 1999Q4 and 2000Q2, etc.). Alternatively, the same value could be used four times in a row. The latter approach leads to similar results.

A recommendation to this effect was recently made by a task force of the employer’s organization VBO.

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Titel: Legal reform and aggregate small and micro business bankruptcy rates: evidence from the 1997 Belgian bankruptcy code
verfasst von: Nico Dewaelheyns
Cynthia Van Hulle
Publikationsdatum: 01.12.2008
Verlag: Springer US
Erschienen in: Small Business Economics / Ausgabe 4/2008
Print ISSN: 0921-898X
Elektronische ISSN: 1573-0913
DOI: https://doi.org/10.1007/s11187-007-9060-3

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