Chapter 7 or 13: Are Client or Lawyer Interests Paramount? * Lars Lefgren Brigham Young University. Frank McIntyre Brigham Young University

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1 Chapter 7 or 13: Are Client or Lawyer Interests Paramount? * Lars Lefgren Brigham Young University Frank McIntyre Brigham Young University Michelle M. Miller Boston University Draft July 2008 * We thank Tina Lindsay and Jocelyn Rick for helpful discussions regarding institutional factors affecting personal bankruptcy. We thank Paul Weitzel, Amanda Boren, Laura Summers, Justin Hansen, Brad Hunter, Mirinda Martin and Henry Tappen for excellent research assistance. We are grateful to David Sims, Joseph Price, Richard Butler, Mark Showalter, Brad Larsen, and seminar participants at Brigham Young University and the University of California at Berkeley for their thoughtful comments. Lars Lefgren can be contacted at Frank McIntyre at and Michelle Miller at

2 Abstract Households often rely on professionals with specialized knowledge to make important financial decisions. In many cases, the professional s financial interests are at odds with those of the client. We explore this problem in the context of personal bankruptcy. OLS, IV, and fixed effects estimates all show that attorneys play a central role in determining whether households file under Chapter 7 or Chapter 13 of the bankruptcy code. We present evidence suggesting that some attorneys maximize profits by steering households into Chapter 13 bankruptcy even when the households objective financial benefits are low and the probability of case dismissal is high. An attorney-induced Chapter 13 filing increases household legal fees and reduces the probability of long-term debt relief.

3 Introduction Individuals rely on informed professionals for many of their important financial decisions. An emerging literature documents the extent to which professionals sacrifice their clients interests to increase profits. For example, Levitt and Syverson (2005) show that real estate agents price clients houses more cheaply than their own. Gruber and Owings (1996) provide evidence that doctors are more likely to perform expensive caesarian sections when there is relatively low demand for their services. Similarly, Harrington and Krynski (2002) discuss how funeral directors often induce households to bury their deceased loved ones in lieu of a less expensive cremation. Chevalier and Ellison (1997) demonstrate that mutual fund managers adjust the risk of their portfolio to maximize fund inflows instead of risk adjusted returns. In this paper, we examine the principal-agent problem in the context of personal bankruptcy. We document the extent to which bankruptcy attorneys take advantage of their clients lack of sophistication to steer them into a bankruptcy option that is lucrative for the attorney but poorly suited to the clients financial situation. Poor advice can cost insolvent households thousands of dollars and usually fails to provide debtors with longterm debt relief. Personal bankruptcy is one of the most important mechanisms through which Americans are insured against adverse financial, health, and personal shocks. Fifteen of every thousand households in the United States filed for personal bankruptcy in 2003, (Lefgren and McIntyre, 2007) on average discharging approximately $36,000 in debt (Culhane and White, 1999). Bankruptcy transfers more money than state unemployment insurance programs (UI) and Temporary Assistance for Needy Families (TANF) 1

4 combined. Despite the importance of personal bankruptcy as consumption insurance, limited information on the part of debtors induces a situation in which access to appropriate debt relief is based in large part upon which law office a debtor happens to enter. A debtor s bankruptcy experience crucially depends on whether he files under Chapter 7 or Chapter 13 of the bankruptcy code. 1 Under Chapter 7, often referred to as liquidation, households may only keep exempt property. All other assets of value are liquidated by a trustee and distributed to creditors. Most of the household s unsecured debts are then discharged (forgiven) and the debtor does not have to give up any of his future income. Alternatively, under Chapter 13, the debtor retains all of his financial assets but promises to follow a court approved repayment plan over a three to five-year period. Which chapter is optimal for a debtor depends on the particulars of his financial situation. Most households that file under Chapter 13, however, pay high legal fees and do not receive long-term debt relief. While it is to be expected that not all bankruptcies will work out as planned, evidence suggests that the chapter under which households file is not purely a function of their financial situation. 2 Using household level data from California, Texas, and Utah, we show that an attorney s fraction of other bankruptcies filed under Chapter 13 explains percent of the variation in chapter selection, even controlling for the financial situation of filing households. This relationship is by far the single most important 1 During the time period in question, Chapter 7 and Chapter 13 relief was available to all debtors. Relief under Chapter 11 was also available to individual debtors, but few debtors chose that option because of the significant cost of filing bankruptcy under Chapter For example, Lefgren and McIntyre (forthcoming) report that the fraction of personal bankruptcies filed under Chapter 13 ranges from 0.03 in North Carolina to 0.62 in Georgia, suggesting legal culture plays an important role in chapter choice. Sullivan, Warren, and Westbrook (1998) emphasize that debt loads and repayment ability appear similar for Chapter 7 and Chapter 13 filers. Braucher (1993) presents qualitative evidence on the attorney s role in the chapter decision. 2

5 observable predictor of which chapter gets filed and it holds after either (1) instrumenting the actual attorney s fraction of bankruptcies filed under Chapter 13 with a measure of average attorney filing behavior in the debtor s neighborhood or (2) using an identification strategy based on neighborhood fixed effects. Firms specializing in Chapter 13 collect more for these bankruptcies, although less payment is required upfront. Yet these firms do not offer benefits in terms of lower dismissal rates or more manageable payment plans. Indeed, our instrumental variables (IV) estimates, which focus on households that chose attorneys based on geographic convenience, suggest that those who file under Chapter 13 with Chapter 13 specialists are often objectively poorly suited for this type of bankruptcy and have high dismissal rates. While attorney specialization yields few benefits for clients, it appears consistent with firm profit maximization. Large firms and firms with a client mix better suited for Chapter 13 bankruptcies tend to specialize in Chapter 13. This is consistent with a model in which firms that expect to file a large number of Chapter 13 bankruptcies engage in fixed investments to reduce the marginal costs of filing such cases. Thus, firms encourage Chapter 13 when the cost is low enough to rationalize (from a profit maximization perspective) pursuing the higher court-regulated payment available under this chapter. While we cannot test the hypothesis that attorneys have different views regarding the advantages of each type of bankruptcy, attorney specialization is empirically consistent with debtor interests being subordinate to firm profits. Ultimately, a typical lawyer-instigated decision to file under Chapter 13, as opposed to Chapter 7, leads to a 3

6 substantial transfer of wealth from insolvent households to specialized attorneys with a reduced probability of long-term debt relief. Review of the Literature In addition to the empirical principal-agent literature cited in the introduction, our paper relates to a large existing literature on personal bankruptcy found in both the economics and legal disciplines. Most closely related to our analysis is a set of papers that explore factors driving a household s decision regarding bankruptcy chapters. Nelson (1999), Domowitz and Sartain (1999), Sullivan and Worden (1990), Li and Sarte (2002), and Sullivan et al. (1988) all find that financial incentives play a role in the choice of bankruptcy chapter. However, many other economists note that legal culture and the choice of attorney also play important roles in the chapter decision. Specifically, Lefgren and McIntyre (forthcoming) find that the propensity to file under Chapter 13 of the bankruptcy code varies greatly across localities. Because these differences are extremely persistent and exist across adjacent states with seemingly similar populations, they conclude that the differences in the proportion of Chapter 13 filings are likely due to legal culture. Sullivan et al. (1994) also argue that all of the variation across bankruptcy courts in chapter choice cannot be explained by state laws, by the behavior of particular individuals or by other non-legal factors. The authors develop a model in which the local legal culture is dominated by lawyers. According to this model, the lawyer, due to specialty, moral preference, or stereotype influences the chapter choice. Braucher (1993), Neustadter (1986) and Sullivan et al. (1988) all provide important qualitative 4

7 evidence that lawyers often steer households toward one particular bankruptcy alternative. Our paper is also closely related to the medical literature examining variation in treatment choice across providers and locations. Health economists have widely documented the variation in physician practice styles which cannot be explained by income, insurance, or patient preferences. Recent examples including Chandra and Staiger (2004), Epstein, Ketcham and Nicholson (2005), and Grytten and Sørensen (2003) show that choice of service provider plays an important role in the type of treatment patients receive. Chandra and Staiger (2004) and Allgood and Bachmann (2006) highlight the health benefits that patients receive from physician specialization. The current study makes three contributions to the existing literature on chapter choice. First, we quantify the magnitude of the attorney s role in chapter choice. Second, we address concerns that the apparent role of lawyers is driven by the endogenous sorting of clients to attorneys. Third, we show that attorney Chapter 13 specialization is on average detrimental to clients and plausibly driven by profit maximization on the part of the attorney. Our paper also adds fresh evidence regarding the problems of principal-agent relationships when the principal (the insolvent household in our example) is unsophisticated. Institution Background Personal Bankruptcy in the United States For households unable to service their debts, personal bankruptcy is a primary instrument of debt relief. Federal authority for bankruptcy is found in Article 1, Section 5

8 8 of the United States Constitution. For this reason, many aspects of bankruptcy are uniform across states. When households file for bankruptcy, creditors must stop all collection measures; this means that creditors must cease foreclosure proceedings, cannot send the debtor correspondence, and must stop all garnishments. Once they petition for bankruptcy, debtors must decide whether to file under Chapter 7 or Chapter 13 of the bankruptcy code. Under Chapter 7, households may have to liquidate their assets. Any proceeds are then distributed among their creditors. This process is fast and simple; Chapter 7 debtors are able to obtain a speedy discharge of most unsecured debts and remove some judicial liens. On the other hand, under Chapter 13, debtors keep their property and instead agree to repay their debts using their future income. Chapter 13 cases are comparatively complex and lengthy. From 1999 to 2001, Lefgren and McIntyre (forthcoming) report that 70.5 percent of all personal bankruptcies were filed under Chapter 7. A Chapter 7 case begins when the debtor files a petition with the bankruptcy court. In addition to the petition, the debtor must detail his assets, liabilities, monthly income, and average monthly expenses. After the petition is filed, a Chapter 7 bankruptcy trustee holds a meeting of creditors, during which the trustee and creditors may ask the debtor questions regarding these documents. After this meeting, the trustee can gather and sell debtor assets. The Bankruptcy Code, however, allows the debtor to keep certain exempt property. Specifically, debtors may keep assets with a value below the personal and homestead exemption levels. These exemption levels vary dramatically across states. For example, Florida has an unlimited homestead exemption while Delaware has none. After the debtor s assets are liquidated, the proceeds are used to 6

9 repay creditors and the debtor is discharged (released from liability) of any remaining debts. In other words, all remaining debts are then forgiven. While the Chapter 7 bankruptcy code allows for contested filings and the liquidation of assets, the typical case involves neither of these. According to conversations with bankruptcy attorneys, often no creditors attend the meeting of creditors. Additionally, the large majority of Chapter 7 cases involve no non-exempt assets that are profitable for the trustee to sell. For this reason, the typical Chapter 7 bankruptcy is quick and simple both for the attorney and for the client. Furthermore, only a small fraction of such bankruptcies are dismissed. In our sample of Chapter 7 filings, only 3 percent were listed as being dismissed. Not all households can file for Chapter 7 bankruptcy. Households who already filed for Chapter 7 bankruptcy within the past seven years are ineligible. Additionally, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) restricted eligibility for Chapter 7 bankruptcy on the basis of household income. 3 Finally, United States trustees, who represent creditor interests, may attempt to force individuals to file under Chapter 13 if it is clear that the debtors possess the ability to pay a substantial fraction of their debts. Rarely are the income restriction or trustee objections an obstacle for households considering bankruptcy. Under Chapter 13, households retain all of their assets and instead agree to repay some of their debts according to a court ordered payment plan lasting between three and 3 In a sample of 1,938 cases filed nationwide between November 1998 and August 1999, Flynn and Bermant (2000) only found two petitions which were filed under Chapter 7 but failed the means test. Similarly, Culhane and White (1999) estimated that only 3.6 percent of debtors would be barred from Chapter 7 when a means test was enacted. True to speculation, within the first year of its enactment, the Acting Director of the Executive Office of the U.S. Trustees testified that approximately 0.5 percent of Chapter 7 filers were being affected by the means test (Tabb and McClelland 2007). 7

10 five years. Debtors pay their projected monthly disposable income, calculated as the difference between their monthly income and monthly budgeted living expenses, into the Chapter 13 payment plan. An in a Chapter 7, a Chapter 13 case begins when the debtor files a petition with the bankruptcy court. Again, the debtor must detail his assets, liabilities, monthly income, and average monthly expenses. After the petition is filed, however, the legal proceedings around a Chapter 13 become more complex. Following the creditor s meeting, lawyers must complete a Chapter 13 repayment plan. This plan, described in further detail below, specifies the amount debtors will pay to the trustee every month. After a judge confirms the plan (decides that the plan is feasible and meets the standards set forth in the Bankruptcy code), the Chapter 13 trustee will begin to distribute funds to creditors. The funds are first disbursed to the debtor s lawyer, then to creditors with priority claims, and finally, any remaining funds are used to repay creditors with unsecured claims. Upon completion of the plan, the household s remaining debts are discharged. The Chapter 13 discharge is often referred to as the super-discharge; in addition to the debts discharged under Chapter 7, Chapter 13 debtors can discharge debts from property settlements following a divorce, willful and malicious injury, governmental fines and penalties, unpaid taxes, certain fraudulent tax filings, fraud, embezzlement, larceny, and damages from personal injury civil action. Significantly, Chapter 13 bankruptcy also allows debtors to retain possession of collateral even if clients are in arrears with their payments. Often, households will file under Chapter 13 to stay in their home or keep an automobile. Debtors can file under Chapter 13 as frequently as every two years. 4 The process of creating a household budget and securing 4 Prior to the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), households could file a Chapter 13 bankruptcy every six months. 8

11 the approval of the payment plan involves substantially more paperwork and time relative to a Chapter 7 bankruptcy. Relative to Chapter 7, Chapter 13 is advantageous for some households. But, it is a poor choice for many debtors. The benefit of a Chapter 13 is that debtors may keep all of their assets. However, in order to discharge its debts under Chapter 13, a household must complete its repayment plan. Thus, Chapter 13 is designed for households with a continuing ability to earn income and minimize future expenditures. If a debtor is unable to commit to a long-term plan, his case will be dismissed, and he will be liable for all his original debts as well as additional court and lawyer fees. According to Lefgren and McIntyre (forthcoming), while 29.5 percent of bankruptcies are filed under Chapter 13 of the bankruptcy code, the majority of these bankruptcies are dismissed (60 percent) largely due to nonpayment on the debtor s part. Another 12 percent of the Chapter 13 filings are ultimately converted to Chapter 7 for the same reason. Thus, Chapter 13 bankruptcies only represent 10 percent of bankruptcy discharges. For these reasons, the majority of households filing under Chapter 13 do not receive long-term benefits. Lawyer Specialization Lawyers vary significantly in the fraction of bankruptcies they file under Chapter 13. Figure 1 is a histogram showing the distribution of lawyers in California, Texas, and Utah by the fraction of bankruptcies they file under Chapter 13. This histogram demonstrates the large spread in lawyer behavior. 42 percent of lawyers file less than 10 percent of their cases under Chapter 13 of the bankruptcy code. On the other hand, 20 percent of lawyers file more than 40 percent of bankruptcies under Chapter 13. If 9

12 bankruptcy clients shop for lawyers who meet their specific financial situations, specialization may not indicate that lawyers play a significant role in determining chapter choice. On the other hand, if filing households are relatively unsophisticated when it comes to selecting a lawyer, the high degree of lawyer specialization suggests that the attorney is crucial in a household s choice of bankruptcy chapter. Braucher (1993) effectively documents the role that attorneys play in guiding typically unsophisticated clients towards one type of bankruptcy or another. 5 Attorneys can influence clients to file under Chapter 13 by emphasizing the benefits of retaining secured assets, the morality of repaying creditors, and access to future credit. 6 Other attorneys shift households towards Chapter 7 bankruptcy by highlighting the difficulty of maintaining the payment plan, the moral obligations to provide financially for their families, and the predatory nature of some creditors. Braucher finds that clients' guilt and loss of self-esteem makes them highly vulnerable to lawyers' influence, whether exercised unwittingly or deliberately. Thus, she concludes that attorney practices have more effect on chapter choices than features of the law conventionally thought to be important. Similarly, Sullivan et al. (1988) find that among other factors, attorneys greatly influence the choice of chapter. Using data collected during surveys, the authors find that nearly 32 percent of debtors consulted attorneys specializing in bankruptcy while the remaining debtors sought counsel from more general practitioners. The authors 5 As Braucher (193) noted, except for conversion, consumer bankruptcy clients are not typically repeat clients. First time bankruptcy clients typically have little information regarding the costs and benefits of each type of bankruptcy. Additionally, social stigma associated with personal bankruptcy likely reduces word of mouth transmission of peoples bankruptcy experiences. 6 A Chapter 13 bankruptcy stays on an individual s credit report for seven years as opposed to ten for Chapter 7 bankruptcies. Anecdotally, however, households filing under Chapter 7 bankruptcy have better access to credit immediately after filing for bankruptcy according to Braucher (1993). This is because they no longer have additional credit obligations and lose the option value of filing under Chapter 7 again for the next seven years. 10

13 discover a positive, moderate unconditional correlation (r = 0.27) between seeing a bankruptcy specialist and filing under the more complicated Chapter 13 of the bankruptcy code. This suggests that attorneys may exert an important influence over whether debtors file Chapter 7 or Chapter 13. While it seems plausible that many lawyers steer clients toward one type of bankruptcy, it is useful to consider what drives this behavior. Lawyer specialization may occur due to the complexity of Chapter 13 bankruptcies. Filing under Chapter 13 of the bankruptcy code requires additional paperwork relative to Chapter 7. First, lawyers must file a repayment plan for all Chapter 13 cases. This requires a detailed collection and investigation of a client s receipts and bank statements. Lawyers must then create a comprehensive itemized budget that their clients must follow over a three to five year period. The paperwork, planning, and organization required to complete this task is substantial. Additionally, the court must confirm Chapter 13 bankruptcies, a process which is often more difficult and time consuming than under Chapter 7. With the 2005 amendment of the bankruptcy code, filing for Chapter 13 bankruptcy became even more difficult. Lawyers must now complete an additional form, the Statement of Current Monthly Income and Calculation of Commitment Period and Disposable Income Form (Form 22C). With 60 lines of exceptionally detailed information, this form particularizes the debtor s monthly income and expenses. Each entry requires thorough documentation; without the proper clerical system, disorganized lawyers may find the task daunting. The form also requires lawyers to predict the debtor s future income and expenditure. While more difficult to file, the payment structure may provide a financial incentive for lawyers to file under Chapter 13, whether or not it is in the client s best 11

14 interests. Chapter 7 attorney fees are unregulated by the courts and households typically pay the entire fee upfront. With Chapter 13 on the other hand, households usually pay some fees upfront; the majority of the fees however are collected as part of the household s payment plan. Because Chapter 13 fees are rolled into a payment plan, households may be relatively insensitive to cost of such a bankruptcy. Perhaps for this reason, individual bankruptcy courts set norms for Chapter 13 compensation; fees above a customary limit are subject to special scrutiny. Thus, attorney fees are tightly clustered around this informal limit. 7 Typically, the customary Chapter 13 fee is much higher than the equilibrium Chapter 7 fee set by the market. From a 2007 sample of two Chapter 7 and two Chapter 13 filings from each of the 90 bankruptcy districts, attorney fees for Chapter 13 bankruptcies averaged $2,657 compared to $905 for a Chapter 7 bankruptcy. In the Chapter 13 repayment plan, attorney fees are given priority status relative to other creditors; their fees may displace payments to other creditors. Thus, even if the plan fails, attorneys collect the majority of their payment. 8 As an example of this, we drew a random sample of 54 dismissed (unsuccessful) Chapter 13 bankruptcies filed in Texas in For these 54 cases, the average lawyer fee was $2,055. The final trustee report showed that the average dismissed case lasted 13 months. Despite the rapid dismissal of the majority of these cases, lawyers still received $1,376 on average 66 percent of the nominal fee. In discharged cases (which we did not sample), we know the 7 See Braucher (1993). Note that these fee limits increased in the aftermath of the 2005 law change. The averages we report here are from February 1, When we look at fees as an outcome variable, we restrict our sample to pre Braucher (1993) documents that in some jurisdictions, the price differential between Chapter 13 and Chapter 7 bankruptcies is much smaller. In these jurisdictions, lawyers only rarely file bankruptcies under Chapter

15 lawyer is fully paid; thus a lawyer s unconditional expected payment from a chapter 13 filing was 80 percent of their fee. 9 The average unsecured debt in these dismissed cases was $19,803; households repaid $302 on average. Secured debt averaged $21,546 with $2,280 in principal repaid and $598 in interest. For this small Texan sample, even when a case was dismissed, the attorney received substantial compensation though a very small fraction of the other debts was repaid. In 22 out of 54 dismissals, the lawyer was paid more than all other creditors combined. Thus, while Chapter 13 bankruptcies are more difficult to file than Chapter 7 bankruptcies, they generate more revenue. Additionally, firms can engage in investments to lower the marginal cost of filing Chapter 13 bankruptcies. 10 These institutional factors suggest the economic model of attorney specialization contained in the appendix and summarized here. Suppose that firms can undertake investments in technology, 11 personnel, or human capital to lower the marginal costs of filing bankruptcies under Chapter 13. Firms that expect to file enough Chapter 13 bankruptcies would find it optimal to undertake such investments. Investments made to lower the cost of filing bankruptcies under Chapter 13 lead to law firm specialization. More specifically, investing firms find it optimal to steer a higher fraction of households into Chapter 13 than non-investing firms, even holding client mix constant. There are two testable implications of this model. First, larger firms will file a higher fraction of bankruptcies 9 60 percent of 2003 Chapter 13 cases in Texas were dismissed..4*1 +.6*.66 = Chapter 7 bankruptcies are relatively simple to file (at times they are even filed without the help of an attorney) which is why we do not consider the possibility that attorneys could engage in investments to reduce the cost of filing for Chapter 7 bankruptcy. 11 Specialized software programs automate much of the bankruptcy filing process. According to attorneys, this software is more helpful for the filing of Chapter 13 bankruptcies than the filing of Chapter 7 bankruptcies. 13

16 under Chapter 13 than smaller firms. The second implication is that firms with a client mix better suited for Chapter 13 will be more likely to file any given bankruptcy under Chapter 13. Similar implications can be obtained from a learning-by-doing model in which attorneys become better at filing Chapter 13 bankruptcies with practice. Our theoretical framework suggests that attorneys will steer households towards the bankruptcy option that maximizes profits, even at the expense of their clients best financial interests in some cases. Specialization may, however, be beneficial for bankrupt households. Households that file under Chapter 13 with firms specializing in this type of bankruptcy may enjoy better financial outcomes or lower costs than households that file Chapter 13 bankruptcy with unspecialized firms. We test this by comparing the filing costs and dismissal rates of households that have filed a Chapter 13 with different firms. Of course, specialization likely reflects different attorney beliefs regarding the relative benefits of Chapter 7 and Chapter 13 bankruptcy. Lawyers may also vary in how seriously they take their obligation to look after their clients best interests. These hypotheses cannot be tested, however, with available data. Description of Data We use several different data sources to examine the role of attorneys in the bankruptcy chapter decision. Bankruptcy data comes from Public Access to Court Electronic Records (PACER), the bankruptcy courts centralized registration and billing website. 12 While the names of bankrupt individuals are publically available, additional 12 Each court operates its own database with case information. Launched in 1997, courts slowly began to use PACER s electronic database system. The last court adopted the PACER system in

17 information is difficult to obtain. A filer s assets, debts, income, address, and lawyer, for example, are only available on his bankruptcy petition. Therefore, our dataset is limited to three bankruptcy courts which gave us access to their electronic records: Utah, Texas Northern, and California Northern from the period 2000 to The Utah sample is a census of bankruptcies from early 2000 to late 2004; our sample includes all 65,957 cases filed in Utah during that time. On the other hand, the Texas and California data are samples from 2003 to 2006; these samples include 30,575 of the 113,412 and 24,088 of the 78,263 cases filed in the Northern Districts of Texas and California respectively during these three years. 36 percent of the bankruptcies on our sample were filed under Chapter 13 relative to just under 30 percent in the U.S. prior to the 2005 bankruptcy reform and just over 20 percent in The filing rates for the states in our sample are also somewhat higher than the nation as a whole. 13 For each petition in our sample, we have information on bankruptcy chapter, filer address, lawyer identity, and lawyer location. In addition, we observe whether the case was dismissed or received a discharge of debts. Because we know the lawyer used in each case, we can calculate the fraction of bankruptcies (excluding the reference individual) filed under Chapter 13 for each attorney. 14 Filer address information was used to merge in 2000 Census block level data. This provides rough information on 13 The national average was 15 filings per 1,000 households in For approximately the same time period, California s filing rate was 16, while Utah s filing rate was 28, and Texas was 8. In terms of demographics, capita income in 2006 was $25,287 in the entire United States, $21,016 in Utah, $26,974 in California, and $22,501 in Texas. The foreign born percentage was 13 percent in the United States, 8 percent in Utah, 27 percent in California, and 16 percent in Texas. The black percentage was 12 percent in the United States, 1 percent in Utah, 6 percent in California, and 12 percent in Texas. Median age was 36 in the United States, 28 in Utah, 34 in California, and 33 in Texas. We control for observable demographic differences in the regressions. 14 In robustness checks, we redo our analysis calculating the fraction of bankruptcies filed under Chapter 13 by the law firm. In these specifications, the law firm is defined by the address on the bankruptcy records. The results are virtually identical. 15

18 demographics, income, and housing values of the bankrupt. Table 1 shows sample means of the filing information and block level demographics. The Census block data suggest that nearly two thirds of the population is married and another 11 percent is divorced. While the large majority at the block level has completed high school, about one fifth of the population has obtained an undergraduate degree. The average median income in the Census blocks is between $40,000 and $50,000, with the average unemployment rate at 3.5 percent. The block level data also indicates that approximately 60 percent of bankruptcy filers are homeowners. Finally, almost the entire sample, 92 percent, resides in an urban Census block. In addition to our primary data set, for 1,965 households that filed for bankruptcy in Utah during the first half of 2000, we collected more detailed information from the Statement of Financial Affairs. For these households, we manually collected income from the prior year, debt and asset levels, and household composition. Finally, we collected the same information for a sample of 16,735 Texas filings for which the court provided machine readable Statements of Financial Affairs. From this sample we exclude households with over $500,000 of unsecured debt. There were fewer than 20 of these outliers which were, in many cases, obviously erroneous. 15 Summary statistics for these two samples are also provided in Table 1. The means of the Census block group variables are generally similar to those of our baseline sample. We can also examine summary statistics of financial variables reported in the Statements of Financial Affairs. We see that in Utah and Texas, households earn about $2,500 and $3,100 per month, 15 This cleaning did not substantially affect our conclusions, although in a couple cases it had a large impact on reported means. For example, one filing reported debts in excess of seven billion dollars for an unsecured lease. 16

19 have secured debt levels of about $103,000 and $83,000 and unsecured debt levels around $46,000 and $47,000 respectively. We use two additional samples of data near the end of the paper. The first is a set of 3,878 Texas filers in 2004 for whom we have information on prior bankruptcy filings as well as their Statements of Financial Affairs. This allows us to perform our analysis on a set of first time filers. Doing so avoids the problem that prior filers of a Chapter 7 bankruptcy may be eligible to file only under Chapter 13 bankruptcy. Additionally, we address the concern that clients of lawyers who disproportionately file under Chapter 13 bankruptcy may be more likely to have filed under Chapter 13 bankruptcy already due to the high dismissal rate of such bankruptcies. Lastly, we wish to look at bankruptcy outcomes, and so, for 8,790 households in our Texas data, we collect information on dismissal rates, reported household budgets, and legal fees. Empirical Strategy One of our primary empirical objectives is to document the role attorneys play in the chapter decision; in this section we outline our methodology. We later use analogous methods for examining the consequences of filing with a particular attorney on other bankruptcy outcomes including the dismissal rate, appropriateness of Chapter 13, and legal fees. Note that we examine a sample of households that actually filed for bankruptcy. To the extent that a client s decision to file for bankruptcy, regardless of type, depends on lawyer behavior, our empirical models will be misspecified. It seems plausible, however, that most households are in sufficiently dire financial straits that the decision to file for bankruptcy is inelastic to attorney behavior. Braucher (1991) reports 17

20 By the time [debtors] consult a lawyer, they may have been living on credit card advances for six months or a year after losing a job or undergoing a divorce. We therefore assume that clients inelastically file for bankruptcy and simply choose between Chapter 7 and Chapter Our base empirical specification is a linear probability model of the following type: (1) chapter13 = X β + α frac13 + ε ij i ji ij where chapter13 ij is a binary variable equal to one if individual i filing with attorney j files under Chapter 13 of the bankruptcy code and zero otherwise. X i is a vector of household level characteristics correlated with the decision to file under Chapter 13, and frac 13 ji is the fraction of an attorney s clients who file under Chapter 13, excluding the reference household, i. Going forward, we will refer to this term as fraction 13. We use frac 13 ji as a proxy for the lawyer s underlying propensity to file households under Chapter If attorney assignment were random, or if the vector X i were sufficiently rich that lawyer assignment was conditionally orthogonal to the residual, α would represent the causal effect of being assigned to a lawyer with a higher propensity to file under Chapter The impact of lawyer behavior on the probability that a household files for bankruptcy cannot be measured using our data. It seems implausible that this would be an important concern, however, as nearly all lawyers file some bankruptcies of each type. To the extent that it is more profitable to file a client under the non-preferred chapter than to not file them at all, lawyers have a strong incentive to provide the type of services that keep the client from leaving their office. Additionally, households that are pushed in a direction contrary to their best financial interests retain the option to consult a different attorney. Finally, to the extent that pushing people towards Chapter 13 bankruptcy, which typically yields the fewest financial benefits, causes them not to file for bankruptcy at all, our estimates will be biased downwards. 17 We also experimented with adjusting frac 13 ji for the observable characteristics of the lawyer s client mix. The results, shown later in our robustness checks, are virtually identical. 18

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