Evaluation of Singapore’s Bankruptcy Laws and their Effect on Entrepreneurship

Entrepreneurship is one of the key focuses of Singapore’s overall economic growth plan and recent Government policy and funding reflects this. Over the past 10 years, a sleuth of schemes has been unveiled by various Government agencies targeting various ways to boost entrepreneurship and improve the success rates of new businesses. However, Singaporeans seems to be held back by a cultural reluctance for entrepreneurship. The Global Entrepreneurship Monitor Survey (GEMs) of 2005 [1] placed Singapore 16 out of 22 OECD countries, with a Total Entrepreneurial Activity Index of 4.9 against a mean of 6.3 amongst OECD countries. In efforts to explain the low entrepreneurial propensity of Singaporeans, a particular myth has arisen; That Singapore has unusually harsh bankruptcy laws which are not as “pro-entrepreneur” as it should be.

A more ‘forgiving’ bankruptcy law has been both quantitatively and qualitatively found to boost entrepreneurship. (Mankart and Rodano, 2007 ; Armour and Cumming 2008 ; Peng et al 2007 ; Lee et al, 2008 ; Lee et al 2010). Lenient bankruptcy laws both lowers the barriers of entry and exit from the market, making the cost of failure less onerous, while at the same time, allowing for entrepreneurs to have a “fresh start” and a new opportunity to pursue another entrepreneurial venture.

It is the harsh reality that majority of entrepreneurs fail. In 2009 alone, for every 100 new firms created in Singapore, 86 firms ceased operations. While failure does not equal to bankruptcy per se, it is indicative of monetary losses suffered by the entrepreneurs, and when too substantial, bankruptcy inevitably ensues. With the high probability of failure for a new start-up, potential entrepreneurs can, and will be, deterred by the severe penalties harsh bankruptcy laws poses on them. In addition, should an entrepreneur fail and goes bankrupt on a venture, harsher bankruptcy law reduces the chances of an entrepreneur gaining a “fresh start” and pursue another venture, a huge loss considering ventures run by people with prior entrepreneurial experience generally have perform better. (Sorenson and Chang, 2006)

Bankruptcy laws however, are double edged. Too lenient bankruptcy laws will lead to moral hazard on the part of the entrepreneurs and tightening of credit supply by the lenders (Armour and Cumming, 2008), resulting in low levels, if any, of lending for new ventures and a complete collapse of the entrepreneurial landscape. Hence, a balance must be sought between the two extremes to foster a healthy entrepreneurial environment. Globally, European countries and the United States are still tweaking their policies to maintain this delicate balance. Their actions, however, are moving in opposite directions; the United States is toughening up their bankruptcy stance [2] while European countries are looking to soften it. [3]

This paper hence attempts to evaluate Singapore’s bankruptcy laws by cross-comparing them with other countries and with established literature and conclude with recommendations, if any, for change in Singapore’s bankruptcy laws.

Literature Review and Basis for Comparisions

It must be noted here that bankruptcy is often divided into personal bankruptcy or bankruptcy of a corporation. However, in this discussion, bankruptcy will always refer to personal bankruptcy as 1) entrepreneurs have less likely to incorporate their nascent business due to the costs and length of time involved and 2) entrepreneurs are likely to put up their own assets as collateral against borrowing, hence a corporate bankruptcy is equal to a personal bankruptcy.

Bankruptcy laws can affect entrepreneurship levels both directly and indirectly. The direct effect looks at the downside effect of failure; a larger downside effect would discourage potential entrepreneurs from starting a new venture. Mankart and Rodano (2008) sum up this effect when they state that a more forgiving bankruptcy law offers entrepreneurs partial insurance against the consequences of failure. Armour and Cumming (2008) also concur when they conclude that the severity of bankruptcy laws determines the consequences of failures and, as a result, entrepreneurship levels. Lastly, Peng et al (2007) concludes that by limiting the downside risk of failure, an entrepreneur-friendly bankruptcy law increases entrepreneurial levels as it encouraging risk-taking by entrepreneurs.

The indirect effect is the growth of entrepreneurship through the increase the number of bankruptcy filings. Although it seems paradoxical, an increase in bankruptcy filing is indicative of a vibrant entrepreneurial culture. By allowing inefficient firms to fail gracefully, resources can be redistributed to other more efficient firms in the economy and allow the entrepreneur to pursue other, more promising, avenues. Hamao et al (2002) concludes that failing firms who do not exit, will continue to consume resources that could have been put to more productive use. (Peng et al,2007) explains this using a real options perspective concluding that an increase in the number of corporate bankruptcies is indicative of a vibrant entrepreneurial economy. Finally, Knott and Posen (2005) wraps up that failure of excess entrants benefit surviving entrepreneurs through to three mechanisms; selection effects, competition effects and spill over effect.

Therefore, a more lenient bankruptcy law will foster entrepreneurial development in society as a whole both directly and indirectly.

Combining the work done by ), Mankart and Rodano (2007), Peng et al (2007), Armour and Cumming (2007 , Lee et al (2008) and Lee et al (2010), 7 factors in which to wholesomely evaluate Bankruptcy laws by emerge and form the basis of comparison for this paper. They are:

‘Fresh Start’ after Liquidation Bankruptcy

Bankruptcy law can be either discharging the bankrupt individuals from debt or allowing the pursuit of bankrupt entrepreneurs for several years. (OECD, 1998) Discharging the bankrupt entrepreneurs simply means what creditors cannot pursue for any remaining claims which have not been met. Since future earnings are exempt from the obligations to repay past debt from bankruptcy, this is named a “fresh start” (White, 2001). In the absence of a legally protected “fresh start,” creditors can pursue any remaining claims indefinitely. The time before a bankrupt can be discharged from his debt in a bankruptcy law hence serves to limit the downside risk for an entrepreneur, conceivably resulting in more new ventures. Conversely, without a possibility of a discharge, there is severe downside risk for a failed entrepreneur as he can be pursued for his debt for the rest of his life. Under the United States bankruptcy law, entrepreneurs can possibly receive a fresh start immediately after declaring bankruptcy, whereas in Italy, there are no provisions to discharge bankrupt entrepreneurs from their debts. By comparing Germany and Netherlands before and after their bankruptcy reforms in the late 1990s, Armour and Cumming (2007) finds that by introducing a discharge of 6 and 3 years respectively, there was an increase in self employment by about 4.5%.

Using data from the World Bank database, Lee et al (2008) goes on further to empirically prove that the larger the amount entrepreneurs retain after bankruptcy proceedings, the higher the bankruptcy filing rate in a country which correlates to higher entrepreneurship levels in a country. Lee et al (2010) reaffirms this by concluding that allowing an entrepreneur to retain 63.18 percent of the assets means an 11 percent higher likelihood of new firm entry compared to when an entrepreneur can only retain 38.48 percent of the assets.

Using a different approach, Armour and Cumming (2008) measure the assets held by the debtor at the commencement of bankru