Distance as a Bankruptcy Filing CostFootnote 1

by Vyacheslav Mikhed and Barry Scholnick

October 2012

Note: While abstracts are available in both English and French, some research papers are only available in their original language. This document is only available in English.

Abstract

This paper is the first in the literature to test the hypothesis that distance to bankruptcy professionals will impact bankruptcy filing costs. We test this hypothesis using unique Canadian data containing the location and full balance sheet of every Canadian E‑Filer. We also observe the location of the universe of licensed Canadian bankruptcy trustees. We can thus calculate the financial benefits of bankruptcy (unsecured debt discharged minus non‑exempt assets forgone), as well as geographic costs of filing. We find, in rural areas, that higher geographic filing costs will increase the financial benefits from bankruptcy required to motivate a bankruptcy filing.

A central hypothesis in the bankruptcy literature (as summarized by White, 2007 and many others) is that the various costs of bankruptcy impact filing decisions. Social costs such as stigma have been discussed by Gross and Souleles (2002), Fay, Hurst and White (2002) and Scholnick (2012) among others, who argue that declining social costs from stigma will increase bankruptcy filings. Filing costs have also been discussed by Gross, Notowidigdo, and Wang (2012), who argue that these costs could reduce the number of bankruptcies if filers are liquidity constrained and cannot afford the bankruptcy filing fees.

This paper is the first in the literature to examine a new type of cost on the bankruptcy filing process — the costs imposed by geography and distance. We hypothesize that geography matters because bankruptcy filing is an interactive process that requires distressed debtors to interact with bankruptcy professionals (e.g. lawyers, trustees etc.) in order to file. A debtor who lives in an area with a large number of bankruptcy professionals within close proximity will thus face lower geographically imposed filing costs compared to a debtor who lives in areas with few proximate bankruptcy professionals.

A large literature has shown that geographic and distance related costs can impact the interaction between parties to a financial contract, in contexts other than personal bankruptcy filings. Geographic distance has been shown to have an impact on such diverse financial contracts as bank lending (Hauswald and Marquez, 2006) as well as corporate acquisition, commercial real estate trading, and securities investment (Hau, 2001). Other studies have found that banks lend more but at higher costs to borrowers located further away from their physical branches (Degryse and Ongena, 2005), that investors prefer shares of local firms (Coval and Moskowitz, 1999 and 2001), that proximate real estate is traded to decrease asymmetric information (Garmaise and Moskowitz, 2004), and that Initial Public Offerings (IPO) of firms provide different signals to nearby and more distant acquirers (Ragozzino and Reuer, 2011).

Our study adds to this literature on the impact of geography on financial contracts, in showing, for the first time, that geographic distance between the filer and the trustee impacts the personal bankruptcy decision. The new hypothesis proposed in this paper follows a central element of the bankruptcy literature, which states that an individual will choose to file for bankruptcy if the benefits from bankruptcy exceed the costs imposed by the bankruptcy. This paper will examine a specific element of this cost‑benefit trade‑off by testing the hypothesis that an increase in the costs of bankruptcy filing imposed by geographic distance will increase the financial benefits required to make a bankruptcy filing worthwhile to the individual. Our specific testable hypothesis is that if the geographic costs of filing are higher (e.g. if the individual lives in an area that is not well served by local bankruptcy trustees), then that individual will require higher financial benefits from bankruptcy (FBB), in order to overcome these geographic costs of filing, and thus to be persuaded to file. The concept of financial benefits of bankruptcy (FBB) is taken from Fay, Hurst and White (2002), and captures the net effect of the amount of unsecured debt that is discharged in bankruptcy (which is a benefit to the filer) minus the liquidated nonexempt assets which are used to repay creditors (which the filer loses in bankruptcy).

In order to examine the impact of geography and distance on bankruptcy filings, we use a unique database of essentially every electronically filed bankruptcy filing in Canada provided to us by the Canadian bankruptcy regulator, the Office of the Superintendent of Bankruptcy (OSB). Our data consists of detailed balance sheet and location information, provided by the OSB, for every Canadian bankruptcy filing that was filed electronically from 2005 to 2010. In total we observe more than 386,000 bankruptcy filings, each containing the full balance sheet submitted by the filer to the OSB at the time of the bankruptcy. The key reason that we are able to obtain such detailed and extensive data is that Canada has a single bankruptcy regulator (the OSB), and every filing in Canada has to be made to that regulator. This differs from the US, where there is no central bankruptcy regulator, and where bankruptcy filings have to be made to individual bankruptcy court districts. The unique advantage of our Canadian data is that we are able to measure both key elements of our central hypothesis: (1) balance sheet data from individual bankruptcy filings, used to calculate the financial benefits of bankruptcy and (2) location data of filers and trustees, used to calculate geographic costs.

Our study exploits an important element of Canadian bankruptcy law, which is that every bankruptcy has to be filed by a bankruptcy professional specifically licensed by the OSB, which in Canada is called a bankruptcy trustee. The Canadian system of requiring bankruptcy trustees to be licensed is very different from the US bankruptcy system, where essentially any professional can be used to make a bankruptcy filing. Because of this licensing system, our data allows us to identify the specific location of the full universe of every licensed bankruptcy trustee operating in Canada. Combining these data with the information on the exact location of each E‑filer, we are able to generate a number of different measures of the costs associated with the geographic distance between trustees and filers. First, we measure the distance between the filer and the geographically closest trustee. Second, we measure how many trustees are located within a predefined radius of each filer (e.g. 10km, 20km etc.). We argue that the closeness of the nearest trustee or, alternatively, the number of trustees within a certain geographic radius of a filer, can be used as measures for the geographic costs imposed on the filer in order to conduct the various transactions required for bankruptcy. We argue that these measures provide very significant exogenous variation, across the different geographic areas in Canada where the individual bankruptcy filers reside. As an example, our data shows that the number of bankruptcy trustees who are located with a 10 km radius of Canadian bankruptcy filers ranges from a minimum of zero trustees within the 10km radius, to a maximum of 94 trustees within the 10km radius.

Our OSB database not only includes the location of filers and trustees it also includes the full balance sheet of every filer, including all assets and all liabilities at the date of bankruptcy. We use these data to calculate financial benefits of bankruptcy for every bankruptcy E‑filer in Canada in 2005–2010. The concept of the financial benefits of bankruptcy (benefits from debt discharged minus assets lost) was initially developed by Fay, Hurst and White (2002). These authors developed and tested the hypothesis that increased financial benefits (their independent variable) would predict larger number of bankruptcy filers (their dependent variable). In this paper, however, we test the very different hypothesis that increased geographic costs of filing (our exogenous independent variable) will impact the financial benefits of filers (our endogenous dependent variable).

In this paper we argue that the level of financial benefits accruing to the filer when the individual choses to file, is endogenous. This endogeneity flows from the fact that the choice and timing of the decision to file for bankruptcy is that of the individual. Our main exogenous independent variable is the geographic costs of filing, as measured by the supply of trustee services in the geographic area proximate to the individual filer.

An additional element of our study is the recognition that the geographic distance between two points — measured as the shortest distance between those points — may not fully reflect geographic cost, if there are other factors besides simple distance which impact the costs of the filer interacting with a trustee. For example, in densely populated urban areas, traffic congestion and the structure of roads may impact transactions costs in addition to geographic distance. In this paper we propose the argument that, as areas become more rural and less urban, so the impact of issues such as traffic congestion should become less important, and measures of geographic distance between two points should more accurately reflect geographic transactions costs. In order to examine this, we examine a variety of specifications which interact the actual geographic distances relevant to individual filers, with an index of how rural or urban their location is. In this way we can test the hypothesis that individual geographic costs, as measured by geographic distance, should have greater explanatory power as areas become more rural and less urban.

The main conclusion of our study is that we find empirical support for our predicted relationship in rural but not urban areas. In rural areas, we find that one extra trustee within a 10km radius of the individual filer will reduce the financial benefits of bankruptcy by $816.94. This result is consistent with our main hypothesis, that as there is an increased supply of proximate bankruptcy trustees within a 10km radius, the transactions costs imposed by geography will decline, thus the required financial benefits needed to persuade the individual to overcome these costs and to proceed to file will be lower. We also find that the magnitude and level of significance of the estimated coefficient for trustees within a 20km radius is smaller than for trustees within a 10km radius.  In other words, as predicted, the impact on FBB is much larger if there is an additional trustee within the 10km radius compared to an additional trustee within the 20km radius.

In terms of our measure of the distance to the closest trustee, we find that in rural areas, one extra kilometer to the closest trustee will increase FBB by $25.69. This finding is also consistent with our main hypothesis that higher transactions costs related to distance (further from the trustee) will increase the FBB required to persuade the individual to file.

While our results are consistent with our hypothesis for rural areas, our estimated coefficients for urban areas have the opposite signs from that predicted, although the magnitudes of the coefficients tend to be smaller than for rural areas. We thus examine the hypothesis that the impact of geographic distance has a greater impact on FBB as the area becomes less urban and more rural, because issues such as traffic congestion are less relevant for more rural areas. We find support for this hypothesis when we interact the individual level geographic transactions costs terms, with an index of the extent to which an area is urban or rural. These results show that the more rural an area, the more explanatory power the individual level geographic distance measures will have on individual FBB.

Footnotes

  1. 1 Financial support from the Office of the Superintendent of Bankruptcy (OSB) Canada to conduct the research on which this report is based is gratefully acknowledged. The views expressed in this report are not necessarily those of the Office of the Superintendent of Bankruptcy, of Industry Canada or of the Government of Canada. Particular thanks to Janice Jeffs, Stephanie Cavanagh, Gord Kelly and Catherine Dupont for their help with the OSB data. Funding was also provided to Scholnick by the Social Sciences and Humanities Research Council of Canada (SSHRC). (back to footnote reference 1)

This abstract has been reproduced as submitted by the author.