Forum-Shopping and Personal Bankruptcy 1

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1 Forum-Shopping and Personal Bankruptcy 1 Ronel Elul 2 and Narayanan Subramanian 3 This revision: March 2002 Abstract The dramatic increase in U.S. personal bankruptcy filings of the last fifteen years has focused attention on the wide disparities between different states personal bankruptcy exemptions. These differences have been criticized both on the grounds of equity and also because they provide an incentive to move to a state with a higher exemption before declaring bankruptcy, that is to forum-shop. This paper focuses on the latter of these objections. Using data from the Panel Study of Income Dynamics (PSID), we estimate a Nested Logit model of the household migration decision. Our econometric approach specifically avoids the problem of endogenously induced bankruptcy filings by examining the effect of filing propensity, rather than the actual event of filing, on the tendency to migrate to a higher exemption state. We conclude that, while there is indeed evidence that considerations of bankruptcy laws do influence interstate migration, the actual effect is relatively modest. We estimate that, in any given year, roughly 17,000 moves to higher-exemption states are motivated by considerations of differences in bankruptcy laws; by way of comparison, this is roughly comparable to the magnitude of recent estimates of welfare-induced migration. This suggests that the emphasis on differences in exemptions which has been a feature of recent attempts to reform the bankruptcy code is somewhat exaggerated. Keywords: Personal Bankruptcy, Bankruptcy Exemptions, Forum-Shopping JEL Classification Numbers: G33, H73, R23. 1 We are grateful to Andrew Foster and David N. Weil for many helpful discussions, as well as to John Driscoll, Jesse Fried, Rachel Friedberg, Richard Grossman, Pravin Krishna, Bent Sorensen, Nicholas Souleles, Elizabeth Warren and Michelle White for their comments. We also thank two anonymous referees for invaluable comments. Subramanian acknowledges support from the Ehrlich Foundation. 2 Department of Economics, Brown University, Providence, RI 02912, USA. Tel: (401) Fax: (401) GSIEF, Brandeis University, Waltham, MA 02454, USA. Tel: (781)

2 1. Introduction One of the foundations of modern bankruptcy law is the idea that certain property should be exempt from seizure by creditors. 1 Several justifications have been advanced for this principle. From the point of view of efficiency, by retaining access to tools of his trade the debtor is better able to repay his creditors and also continue as a productive member of society; in addition, restricting garnishment of wages allows him to retain his incentive to work. Appeals to equity and fairness are also made, in that debtors have the right to a fresh start with a certain minimal level of assets and also that certain items have little resale value for creditors but retain great sentimental or practical value for the debtors (such as used household effects, wedding rings). One interesting peculiarity of bankruptcy law in the United States is that while the law itself is Federal, states are permitted to opt-out of the federal exemptions and set their own levels; in practice all states have done so, although some still permit the filer to choose between the federal and state exemptions. Recently, attention has been focused on the wide disparities between state personal bankruptcy exemptions. The differences between states can be quite striking, with a single filer in Maryland receiving only a $5,500 exemption, while the same individual in Texas would be able to exempt an unlimited amount of home equity, and up to $30,000 in personal property. 2 These exemptions apply directly to Chapter-7 bankruptcy proceedings, which make up roughly 70% of all personal bankruptcy filings. In a chapter 7 filing, the debtor gives up non-exempt assets in exchange for discharge of his debts; such a discharge may be received only once every seven years. Most other personal bankruptcy cases are filed under Chapter 13 of the U.S. Bankruptcy code. In a chapter-13 proceeding the debtor is able to retain his assets, but agrees to a plan for repaying his creditors (at least in part) over a three to five year period. There is no limit on how often a chapter-13 filing may be made. 3 Chapter 13 is typically favored by homeowners, because it permits them to retain their property by making up any missed mortgage payments. The bankruptcy exemptions affect chapter 13 filings in two ways. First of all, a household filing under Chapter-13 of the bankruptcy code is required to pay his creditors at least as much as they would have received under a Chapter-7 filing (although the payments may be stretched out over several years). In addition, the very existence of a Chapter-7 outside option certainly has an important 2

3 influence on Chapter-13 outcomes as well. A more detailed description of U.S. bankruptcy procedures can be found in Sullivan, Warren and Westbrook (1989). These differences have been criticized on the grounds of equity, 4 and complexity 5 and also because they provide an incentive to move to a state with a higher exemption before declaring bankruptcy, that is to forum-shop. 6 This paper focuses on the last of these objections the ability by debtors to move to a state with a more favorable bankruptcy exemption before declaring bankruptcy. This is of concern from a legal point of view, since it subverts the differences in exemptions between states, as well economically, since it imposes a negative externality upon borrowers in those states which have adopted stringent exemptions rules, who might otherwise receive more preferential treatment from creditors. 7 It should be noted that the federal bankruptcy code legislates using the exemptions associated with the [s]tate or local law that is applicable on the date of the filing of the petition at the place in which the debtor s domicile has been located for the 180 days immediately preceding the date of the filing of the petition, or for a longer portion of such 180-day period than in any other place; 8 in practice, this means that one must have resided in the state of filing for merely 91 days. However, several high-profile bankruptcy filings have been challenged on the grounds that although the move was undertaken more than six months in advance of filing, it was nonetheless fraudulent in intent. 9 There has been an intense effort to reform the bankruptcy code, dating back to at least The current bill, which has been passed by the Senate but still faces several hurdles before it can be enacted, is the Bankruptcy Abuse Prevention and Consumer Protection Act of It contains several provisions which are likely to greatly reduce the incidence of forum shopping. Firstly, there is a proposal to directly target forum shopping by lengthening the domicilary requirement to use a state s exemption to two years. The centerpiece of the bill a provision which would close off chapter 7 as an option for many households, and force them to pay much more in chapter 13 than they would have in the past would also affect forum shopping. In particular, the bill would institute means-testing for households petitioning to file under Chapter 7; those who do not meet these criteria and are channelled into chapter 13 would have to pay as much as possible (excluing only expenses covered in a standardized budget), and not merely more than they would have in chapter 7. This would have a dramatic impact on forum shopping by both reducing the attractiveness of filing in general as well as making the 3

4 state exemptions less relevant for a large class of debtors. Finally, there is a proposal in the Senate version to limit the homestead exemption to $125,000; however this provision is opposed by both the House as well as the current Administration and so is unlikely to be retained in the final version of the bill. We believe that our paper is the first attempt at systematically exploring whether people exploit inter-state differences in bankruptcy laws through selective migration. 10 There are two reasons why we believe that our study is important. First of all, it sheds light on the issue of how practical it is for states to set exemption levels independently of each other. In addition, our study indicates the extent of bias in other studies of bankruptcy which do not account for exemption-induced migration. We conclude that, while there is indeed evidence that considerations of bankruptcy laws influence interstate migration, the actual effect is modest. We estimate that roughly 1% of moves to states with higher exemption limits are found to be motivated by considerations of differences in bankruptcy laws; this corresponds to approximately 17,000 moves (out of an estimated 1.4 million such exemption-increasing moves every year). These figures are of roughly the magnitude of the estimates obtained by other authors (cited below) for welfare-related migration. Furthermore, we conclude that while there is strong evidence that households who are at risk for filing will seek out high-exemption states should they find themselves moving for some reason, they are unlikely to move simply for this reason. Our method involves a Full Information Maximum Likelihood estimation of a Nested Logit model of the household migration decision. Our econometric approach specifically avoids the problem of endogenously induced bankruptcy filing, wherein a household that migrated for reasons other than debt relief to a high-exemption state nevertheless files for bankruptcy following a downturn in its economic fortunes because the high exemption level makes it beneficial to do so ex-post. 11 We do this in two ways: (i) by examining the effect of filing propensity (prior to migration) rather than the actual event of filing, on the tendency to migrate to a higher exemption state, and (ii) by including the exemption limit in the state of filing as one of the covariates. We also control for interstate differences in employment opportunities as well as inter-household differences in innate migration propensities, in determining the effect of filing propensity on the propensity to migrate to a higher exemption state. There have been several other empirical studies of personal bankruptcy. For exam- 4

5 ple, Gropp, Scholz and White (1997) show that borrowers living in states with generous bankruptcy exemptions are more likely to find themselves credit-constrained. In another paper, Fay, Hurst and White (1998) use the PSID to examine the effect of financial benefit and stigma on the decision to file for bankruptcy. Gross and Souleles (1998) also show that even after controlling for changes in risk composition, the propensity to default has increased significantly between 1995 and 1997, which they conclude is consistent with a decline in stigma. Domowitz and Sartain (1999) jointly model the determinants of the bankruptcy decision and chapter choice, as well as providing evidence of the importance of medical and credit-card debt in determining bankruptcy. Repetto (1998) uses the PSID to examine the effect of state exemption laws on wealth accumulation. Sullivan, Warren and Westbrook (1989) use court records on some 2,400 personal bankruptcy filings to develop a picture of an average bankrupt; among other findings, they suggest that bankruptcies are generally involuntary, rather than representing a strategic choice, which is in opposition to the thesis of this paper. 12 Finally, it should also be noted that forum-shopping has been identified as a factor in corporate bankruptcy see Lopucki and Whitford (1991). Implicit in our investigation is the assumption that exemptions do indeed affect bankruptcy filings. On the aggregate level, the evidence is mixed. For example, in studying the Bankruptcy Reform Act of 1978, Peterson and Aoki (1984) and Domowitz and Eovaldi (1993) found no significant evidence that the changes in the bankruptcy code increased bankruptcy rates. Similarly, in a cross-sectional study of state exemptions, Weiss, Bhandari and Robins (1996) found no significant relationship between a state s exemptions and the filing rate in that state. Buckley and Brinig s (1998) results are mixed. On the other hand, in her analysis of the 1978 act White (1987) did find evidence that exemption levels help explain differences in filing rates. Several studies by Nelson also suggest a modest, but statistically significant effect; Nelson (2000) carefully measures the degree to which the 1978 Bankruptcy Reform Act is responsible for the dramatic increase in filings of the past twenty years and Nelson (1999) studies the determinants of choice of filing chapter (treating the homestead and personal property exemptions separately). Finally, Hynes (1998), who relies on several years of data and carefully specifies the state property exemptions, finds a significant effect using several different approaches; among these is a natural experiment which avoids some of the endogeneity problems which might arise in estimating the effect of exemptions on state bankruptcy rates. 5

6 The evidence becomes stronger once one considers individual-level data and also makes use of information on household asset holdings (enabling one to account for the nonlinearity of the exemptions); this is evident in the results of Fay, Hurst and White (1998), who find that the bankruptcy benefit is a statistically significant determinant of filing (see also Repretto, 1998), as well as in our table 4. One other important assumption we make is that the bankruptcy exemptions may be treated as exogenous. This is supported by Hynes and Posner (1999), who do not find evidence that the rate of bankruptcy filing is a significant determinant of changes in bankruptcy laws. On the other hand, Domowitz and Tamer (1997) do find evidence that economic fluctuations (although not bankruptcy filings per se) have sometimes influenced bankruptcy legislation. See also Bolton and Rosenthal (1999), who construct a theoretical model of aggregate fluctuations and the political economy of debt bailouts. Lastly, this paper is also related to the literature on the influence of cross-jurisdictional differences in government programs and laws on migration. For example, strategic migration to states with more favorable laws has been extensively addressed in the literature on Welfare Magnets see Moffitt (1992) and Meyer (1998) for a discussion of the empirical evidence and econometric issues, 13 and taxation (Feldstein and Wrobel, 1998). Buckley and Brinig (1996) examine the interaction between migration and states welfare, bankruptcy and tax laws; their principal interest is the question of whether states use their laws to compete for desirable migrants (or to deter undesirable ones). Finally, it has also been observed that, quite apart from cross-state differences in bankruptcy codes, differences in local legal cultures across jurisdictions within the same state may play an important role in determining the choice of chapter (Sullivan, Warren and Westbrook, 1997) and in the application of the good faith norms which permit judges to disallow a filing in case of debtor opportunism (Buckley and Brinig, 1998). So even though we find a modest role for interstate migration, moving may still have a significant impact on the benefit of a bankruptcy filing through other, less formal, channels. 14 In the following section we present our model of bankruptcy and migration. Section 3 discusses the data, and section 4 the estimation of the model using this data. Finally, the results are presented in section 5. 6

7 2. The Model Consider a household which has not filed for bankruptcy in a given year. 15 think of the household as having several options for the following year: Then one can Do nothing. Move state and then do nothing. File for bankruptcy in the following year in the current state. Move state and then file for bankruptcy in the following year. We represent the household s decision graphically with figure 1. A household has a selection of U.S. states available to it and must choose the one which maximizes its utility. Each state differs from the others in its characteristics, which include both its bankruptcy code as well as other features such as available employment opportunities. To simplify the exposition we assume that there are only two characteristics, the state bankruptcy code and all others. Then each State can be represented as a point in figure 1; the polygon represents the set of all States available to a household in this space. For those with a high propensity of filing for bankruptcy in the following year (the prospective filers ), there is a tradeoff between the exemption levels of states and their other characteristics (such as employment prospects). For those who are not, whom we dub ordinary agents, the bankruptcy exemption is essentially irrelevant. This can be seen in the different indifference curves drawn in the two figures. The key to our analysis is the observation that the optimal decisions of these two sorts of agents differ; in particular, those agents who are likely to file for bankruptcy prefer a state with a higher exemption than those who do not. [INSERT FIGURE 1 HERE.] We are interested in seeing whether a household which is at risk for filing bankruptcy is likelier to move to a state with a preferential legal structure in order to increase its gains from bankruptcy. While what constitutes being at risk is fairly straightforward and intuitive in the context of the welfare debate (e.g. a poorly-educated single mother 16 ), this 7

8 is not the case for bankruptcy. Our approach will instead be to estimate the propensity to file for bankruptcy and then use this to explain the household s migration decisions; we motivate this in the following paragraphs. Examination of the summary statistics found in tables 2 and 3 (in the following section) suggests that households who move to a state with a higher exemption are indeed likelier to subsequently file. For example, while approximately half of the general population of migrants moves to states with higher exemptions, the percentage for those who file in the following year is 79%. One might indeed be inclined to conclude that migration takes place for the purposes of bankruptcy planning merely on this basis alone. But it is important to note that moving to a state with more generous laws may also induce a bankruptcy filing, since it lowers the cost of filing. So such an approach, which we do not take, would be biased in the direction of significance. 17 This is one justification for using an approach based on an estimated filing propensity. The other reasons for taking this approach are, firstly, to more closely model the household s decision-making process (it must make a similar prediction of its filing risk before deciding whether or not to invest in a costly move to a higher-exemption state) and also to allow us to make use of the whole sample of movers, rather than only those who subsequently filed for bankruptcy. For example, not only can we use information on those who will actually file in the coming year, but also those who are close to filing this year but will not file until next year, and so on. This approach is compelling in light of the evidence presented in table 3 below, which suggests that individuals become likelier to move to higher-exemption states as they grow closer (temporally) to filing for bankruptcy. Another approach which one might consider would be to determine whether households which move to a state with a higher exemption are then likelier to subsequently file than the representative resident of the new state. This approach is sometimes taken in the welfare magnets literature (Meyer, 1998). But this would not be a good test of our hypothesis, since a strategic move to a state with a higher exemption does not take place because a household is likelier to file than other households in the new state, but rather because in some sense they are likelier to file than those in the old state of residence. More precisely, forum-shopping is about a household which is at risk for bankruptcy moving in order to improve its position in a bankruptcy filing relative to that in its previous state of residence. 8

9 We now motivate our model in greater detail. Assume that households can freely shift assets across categories. Then it is possible to represent the exemption level in a particular state by a single number E, which gives the sum of the various exemptions in that state. If a household residing in this state has assets A and debt D, then the amount of assets which the household cannot protect should it file for bankruptcy is max[a E,0]. So the household s direct financial benefit from a (chapter-7) bankruptcy filing 18 in this state would be: B =max[d max[a E,0], 0]. (1) What interests us is the impact of bankruptcy on moving. What we have in mind is that a household which believes that it is likely to file for bankruptcy in the following year will move state if it can thereby increase its benefit from filing. So we are naturally led to a model in which the total benefit from filing for bankruptcy in period t, y it, can be viewed as function of its characteristics and information at time t 1. However, we only observe the event of a bankruptcy filing, yit.thatis, y it = X i,t 1 b + µ it (2) y it = 1, if y it > 0; = 0, otherwise. where X i,t 1 denotes a vector of household characteristics at time t 1, including its direct financial benefit B i,t 1 from its state of residence at time t 1, and the µ it are i.i.d. Suppose that we let ȳ it =Prob(yit > 0 X i,t 1) denote the household s propensity to file for bankruptcy in period t conditional on its characteristics and information at time t-1. Then we predict that this should be positively related to whether the outcome of the household s migration decision will increase its financial bankruptcy benefit B. As we have described it, the financial benefit B which a household derives from filing for bankruptcy depends not only on the exemption in the state of filing but also the household s debt and asset levels. It is clear that in fact these should be modeled simultaneously with the household s location and bankruptcy decisions, 19 but we choose to avoid this complication and work instead with the change in exemption level, which we denote by 9

10 E. As we will see below, another reason for doing so is because debt and non-housing wealth are sampled only once every five years in the PSID. In fact, we consider only the change in sign of the exemption, since if a household moves to a state with a higher exemption (i.e. E it > 0), then its financial benefit B should not decrease (whereas the magnitude of this change would not necessarily signify a larger increase in B). Though such a specification permits us to estimate the frequency of forum shopping, it does not allow us to determine the financial loss which it causes, which limits the application of our results. In deriving this model we have made several simplifying assumptions. One assumption is that a state s exemption can be represented by a single number E; this assumption was made so that we could easily compare states, without relying too much on the PSID s household balance sheet data, which is measured infrequently. That is, we assume that households can costlessly convert assets from one class to another which has better protection in bankruptcy (such as home equity). This assumption is controversial, but little evidence exists which can be brought to bear on the question of these adjustment costs; certainly, however, it would be fairly easy to convert cash balances (which usually have limited protection in bankruptcy) to other assets, especially if the household filing owned a home, which is true in approximately half of all cases. Another assumption we have made is that the debt D includes all of the household s debts. In fact, because of data limitations we have not included certain obligations like child support payments and delinquent taxes. 20 Since these obligations cannot be discharged bankruptcy, 21 by ignoring them we may be overstating the benefit of filing for bankruptcy. 22 One might also be concerned that households filing for bankruptcy are, in general, so poor that they should be indifferent to differences in state exemptions (and should also not engage in much pre-bankruptcy planning of any sort); this view has been vigorously propounded by Sullivan, Warren and Westbrook (1989). Similarly, Gropp, Scholz and White (1997) argue that many filers are unlikely to be able to pay the upfront costs needed to finance a move. Although our results provide some support for these asssertions, one should note that they are far from uncontroversial. Indeed, Buckley and Brinig (1998) point out that even Sullivan, Warren and Westbrook s own data provides far from conclusive support for their claims. Barron and Staten (1997) also find that 20% of all filers have sufficient non-housing assets to repay half of their debts, and 10% could repay them in 10

11 entirety from non-housing wealth. Finally, turning to the PSID, of those households who filed for bankruptcy, assets averaged $15,000 and over 10% of petitioners assets exceeded $50, As we show in table 4 below, filers also tend to be significantly more mobile than the average. Taken together with the wide range of state exemptions from $5,500 in Maryland to an unlimited exemption in Florida, Texas and several other states this suggests that quite a few households would indeed have something to gain by moving state judiciously, and even those who did not stand to gain very much could certainly lose as the result of an injudicious move. 24 We can model the household as first deciding whether or not to move and then choosing its destination, in order to examine how the outcome of the relocation decision depends on the household s probability of filing for bankruptcy. Note that this is a model of the decision-making process these decisions of course take place simultaneously. There are thus three choices for the household, indexed by z. If the household decides not to move then z = 1; if it moves to a higher-exemption state then z = 2; and if it moves to a state with the same or a lower exemption then z = 3. This is depicted in figure 2. [INSERT FIGURE 2 HERE.] The household s decision can be viewed in the context of random utility maximization 25 as the choice between a utility Uit 1 for staying in one s state, Uit 2 formovingtoastate with a higher exemption and Uit 3 for choosing a state with a lower exemption. If, as we have suggested, we divide the household s decision into a moving decision and a choice of destination, then it is natural to view the utility of each alternative as being composed of a component due to each decision. That is, we can write for the utility of staying in one s state, U 1 it = V 1 it + ɛ 1 it (3) U 2 it = V {2,3} it + V 2 it + ɛ 2 it (4) 11

12 for the utility of moving to a state with a higher exemption, and U 3 it = V {2,3} it + V 3 it + ɛ 3 it (5) for the utility of moving to a state with a lower or equal exemption. Here V {2,3} represents the component of the household s utility which is common to both alternative 2 and 3 the alternatives in which the household chooses to move state and the ɛ z are error terms (whose distribution is specified below). For purposes of estimation, we normalize Vit 1 =0andVit 3 = 0, and write a linear model for the remaining utilities, namely V 2 it = cȳ it + W i,t 1 d (6) and V {2,3} it = eȳ it + Z i,t 1 f. (7) The coefficient of primary interest to us is c, which gives the impact of the filing propensity on the change in exemption (conditional on moving); our model tells us that it should be positive. We are also interested in e, which gives the impact of bankruptcy on the moving decision itself together with c this can be used to calculate the effect of bankruptcy on the probability of moving to a state with a higher exemption, not conditional on moving itself. In order for this model to be identified we must determine if there are variables which affect the household s bankruptcy decision but should be excluded from a model of its migration decisions. We rely on the fact that the financial bankruptcy benefit B should not enter into the moving decision except through its effect on the filing propensity ȳ. In addition, this is also the case for the interaction of B with triggers of bankruptcy such as unemployment and changes in income, etc. It is also reasonable that the state and federal bankruptcy rates should again not enter directly into the moving decisions. 12

13 3. Data In their 1996 interviews, the Panel Study of Income Dynamics (PSID) asked a number of questions on personal bankruptcy. Among these, respondents were asked to report the year of bankruptcy filing, and the state of filing. We match the answers to these questions with the main PSID file data from 1983 to 1992; this serves as the basis of our analysis. All of the variables from the main PSID file which we use are reported annually, except for non-housing wealth and debt, for which we have data in only 1984 and There are a total of 212 bankruptcies in our sample, which represents a filing rate of 0.32% for the PSID households; this PSID rate is approximately two-thirds of the U.S. filing rate over this period (the difference may be due to either under-reporting in the PSID or the fact that the PSID over-represents poor households who less likely to file). Movers are defined to be those observations for which the state of residence (or the filing state, if the household filed for bankruptcy) in the following year differs from the current state of residence. Of those 212 households who filed in the PSID, 10 moved state in the year preceding filing (although nearly one half moved at some point in the sample). The reader may be concerned that this sample of movers who subsequently filed is too small to allow for reliable estimates. As mentioned above, however, one advantage of our two-step approach is that by estimating a bankruptcy propensity for the whole sample, we are able to use information not only on those who actually filed in a given year, but also those who were close to (or far from) filing. We take special care to adjust the standard errors of our estimates to account for the fact that one of the covariates is a fitted value. 27 For the overall sample of 60,344 observations, by contrast, we have 1,744 households who moved in the previous year. 28 Following Fay, Hurst and White (1998), we drop observations on households after they file for bankruptcy, primarily because after filing a Chapter-7 bankruptcy one is unable to obtain another such discharge for seven years. In addition, these serial filers are unlikely to have many assets and so their decisions would be orthogonal to the concerns of this paper. For each observation in the sample we calculate the total exemption level, which is the sum of the various exemptions for single filers, based on the state of residence (or the state of filing, if the household filed for bankruptcy in that year). 29 In calculating these exemptions we use the 1983 values from Gropp, Scholz and White (1997) for the years 13

14 , and the 1992 values from White (1998) for (see also Weiss, Bhandari and Robins 1996). If its use is permitted by the state s laws, the federal exemption is substituted when higher. These exemption levels are reported (by state) in table 8 and figure 3 in the appendix. Table 2 breaks down the moves into those which led to an increase in the state exemption level and those which either decreased it or left it unaffected. This table was constructed from the entire sample of 60,344 observations (of whom 3% moved state in the previous year), along with 212 filers, of whom 6.38% moved state in the year prior to filing for bankruptcy. 30 [INSERT TABLE 1 HERE.] It is also instructive to consider more detailed statistics for filers, as in Table 3. Consider individuals who move sometime around the time of their bankruptcy filing; approximately 40% of the 212 filers in our sample moved at some point around the time of filing (in addition, some may have moved in the more distant past or future). Table 3 breaks down these filer/movers into the year they moved, relative to their filing year, and then into whether the move decreased or increased their exemptions (the remainder left it unaffected); in each (relative) year these filer/movers number thirteen on average. For purposes of comparison, we also provide information on our control group, those in our sample who never filed; of those, we report what fraction moved in any given year (on average), how many lowered their exemption and how many raised it. [INSERT TABLE 2 HERE.] From this data it appears that individuals seek out states which have higher exemptions in the year prior to filing for personal bankruptcy. It also appears as if they avoid moving to states with lower exemptions. At least some of this seems to involve accelerating (or delaying) moves which would otherwise have taken place, but our limited data does not allow us to address this question. Although these tables are suggestive, they are far from conclusive, which is why we conduct a formal statistical analysis in the following sections. 14

15 In addition, we also use information on state and federal filing rates from the American Bankruptcy Institute and the Statistical Abstract of the United States. These are relevant because they determine both the availability of post-bankruptcy credit (Staten, 1993 and Elul, 1998) as well as the stigma attached to a bankruptcy filing (Fay, Hurst and White, 1998 and Gross and Souleles, 1998). 4. Estimation We first estimate equation 2, which gives the determinants of bankruptcy conditional on the household s information and characteristics and information at time t 1, that is: y it = X i,t 1 b + µ it, (8) whereweobserveyit =1ify it > 0andyit = 0 otherwise. Assuming that the µ it are i.i.d. with a logistic distribution leads to a logit estimation. We then calculate the estimated bankruptcy probability ŷ it = ex i,t 1 b for each agent 1+e X i,t 1 b and use this fitted value as a covariate in the moving equations in place of ȳ i,t. We now make the necessary assumptions on the error terms ɛ so that the household s migration decision is represented by a nested logit specification. In particular, the error terms (ɛ 2,ɛ 3 ) are Gumbel type-b extreme-value random variables with a scale parameter of 1 and a correlation coefficient of ρ, andɛ 1 it is independent of these and has a type-i extreme-value distribution. 31 This leads to : P (z it =2 z it 1) = e cŷit+witd λ 1+e cŷ it +W it d λ P (z it =3 z it 1) = 1 P (z it =2 z it 1) (10) 1 P (z it =1) = 1 P (z it {2, 3}) = 1+e (λi it+eŷ it +Z it f) where I it, defined to be the inclusive value of the moving alternative, is given by ( I it =ln 1+e cŷ it +W it d λ (9) (11) ). (12) The interpretation of this specification is that the household derives a weighted utility 15

16 for the moving alternative based on the two choices following this alternative, and then compares that to the utility from the alternative of not moving. The weight used is λ, which is related to the coefficient of correlation ρ between the error terms within the moving alternative in particular ρ =1 λ 2. We estimate this portion of the model using full-information maximum likelihood estimation. We calculate White standard errors which are adjusted to allow for dependence within (but not across) households. We also adjust the nested-logit standard errors to reflect the fact that the bankruptcy probability is itself a fitted value (Murphy and Topel, 1985 or Greene, 1997). 32 Finally, as a further check we computed the two-step LIML estimates of the nested logit model 33 and bootstrapped these to calculate standard errors. 34 The results, which are not reported in the paper, were similar to the FIML estimates reported above. We now briefly discuss the variables included in the estimations. As far as the bankruptcy regression is concerned, we include information on the household s financial position, as well as other individual characteristics which might result in a higher propensity to file. As mentioned above, this includes the state and federal bankruptcy rates, since these affect the availability of post-bankruptcy credit and the bankruptcy stigma. We also include dummy variables for every year. The most important of the variables, however, is the direct financial benefit B which the household would obtain from filing for bankruptcy. In constructing B we take account of the distinction made in state bankruptcy codes between housing and non-housing wealth, as well as the higher exemption levels available (in some states) to married filers. 35 We also interact this with triggers of bankruptcy such as unemployment and the change in income over the previous year. As we have noted above, the benefit and its interactions serve as the primary source of identification in our model. Also note that we include variables which affect migration since these influence the bankruptcy decision as well; that is W, Z X. The nested logit estimations, that is the joint decision of whether or not to move and if moving, whether to move to a higher or lower-exemption state, depends on many of the same factors, excluding, however, those which are directly related to bankruptcy such as the federal and state bankruptcy rates and the financial benefit B (as well as its interactions). We also include the level of the current state s bankruptcy exemption, since living in a state with a high exemption necessarily makes one less likely to move to a state 16

17 with an even higher one. Of course, we also include the fitted value of the filing probability which we obtain from the bankruptcy regression. One might believe that only a few variables should enter into the lower level of the nested logit - that is the choice of a higher vs. lower- exemption state, conditional on moving. One example might be age, if migration by retirees to high-exemption sun-belt states (like Florida) is important. So one could well exclude even more variables from the estimation of (2). But we did not do so in our reported estimations, because we did not have a clear case for excluding any variables other than those connected to the financial bankruptcy benefit, as mentioned above. In any case, reestimating these equations with more exclusion restrictions yielded qualitatively similar, and in fact, quantitatively stronger, results. 5. Results We explain the results in detail below, but they may be summarized as follows. We find that, conditional on moving state, our fitted bankruptcy propensity is a statistically significant determinant of whether a household moves to a higher or lower-exemption state. We also estimate that, were this propensity set to zero for all households, i.e. were bankruptcy not a factor in migration decisions, then the total number of moves to higherexemption states would be reduced by 17,000 per annum. [INSERT TABLES 3 and 4 HERE.] Table 1 gives the Table 4 gives the results of the logit estimation of the determinants of bankruptcy filing. The results are as expected and in fairly close agreement with those in Fay, Hurst and White (1998), who also use the PSID. For example, the state and federal bankruptcy rates are positively related to filing, the coefficient on household net worth is negative, an increase in income reduces the likelihood of bankruptcy, and losing one s job in the previous year makes one more likely to file. The effect of the financial bankruptcy benefit B is positive (and statistically significant), and the higher-order effect is negative. A household which is very mobile (represented by having lived in many other states) is more likely to file, perhaps because it is less stable in all respects. Older households are less likely to file. Finally, the predicted probability of bankruptcy is 0.35%, (as compared 17

18 with an actual incidence in our sample of 0.32%); for those who actually filed the following year the predicted probability was 0.8%. We can use these results to get a rough gauge for the impact of a law prohibiting forumshopping on the number of filings; for example, one mandating use of the original state s exemption. If one restricts the bankruptcy benefit (and all of its interactions) to remain unaffected by the change in exemption induced by the move, then one can calculate that for the typical household who moved to a higher-exemption state, the risk of filing would go down by about 2.9%. This translates to roughly 275 fewer filings every year over the entire U.S. population. In order to obtain a more precise estimate, however, one would need to model both filing and moving simultaneously; data limitations made this difficult. The results from the estimation of the nested logit specification of the household migration decisions are then reported in tables 5 and 6. [INSERT TABLE 5 HERE.] Table 5 examines the determinants of a household moving to a state with a higher (as opposed to lower or equal) exemption, conditional on moving. As can be seen from equation 10, the coefficients reported here are all normalized by the coefficient λ on the inclusive value; this makes them comparable to those which would be obtained by a logit estimation of the lower level alone. First of all, the coefficient on the bankruptcy propensity is positive and statistically significant at the 5% level; this should be interpreted as support for our hypothesis. The marginal effects allow us to conclude that were bankruptcy considerations not a factor in household decisions i.e. were the propensity set to 0 for all households (instead of the population average), then the overall incidence of exemption-increasing moves would drop by approximately 2 percentage points, from 46.67% (an elasticity of 1%); thus this effect, while statistically significant, is economically quite modest. Of course, for those at higher risk for filing, the effect would be more dramatic. The rest of the variables with statistically significant coefficients reflect other characteristics common to high-exemption states; for example, the coefficient on age in this estimation is positive while the quadratic age term is negative this presumably reflects migration by retirees to higher-exemption sun-belt states such as Florida. [INSERT TABLE 6 HERE.] 18

19 Table 6 gives the (unconditional) estimates of the moving determinants; that is the upper-level estimates of λ, e and f. Recall that we normalized the utilities so that eȳ + Zf gives the utility of moving to a state with a lower exemption. So it is not surprising that the coefficient on the bankruptcy propensity is negative (albeit not significant), since a high propensity of filing should reduce the attractiveness of a state with a lower exemption. In addition, households which are in financial distress (and hence at greater risk for bankruptcy) are less likely to move in general, since both moving expenses and security deposits must generally be paid up-front in cash. 36 Many of the other variables are as expected: for example, education has a strongly significant positive effect on the propensity to move (the better-educated are generally found to be more mobile see for example Costa and Kahn, 2000); home ownership makes moving less likely; having lived in many states in the past puts one at increased risk for moving state again in the future. [INSERT TABLE 7 HERE.] Another way to interpret the results presented in tables 5 and 6 is to use them to compute the effect of the bankruptcy propensity on the probability of moving to a state with a higher exemption, without conditioning on the moving decision itself; that is, to calculate P(z it =2)/ ȳ it. These marginal effects are given in table 7, where we see that a 1 percentage point increase in the probability of filing results in a percentage point increase in the unconditional probability of moving to a higher-exemption state. This means that a household whose filing propensity is equal to the average propensity for filers (0.8%), is 0.03 percentage points more likely to move to a higher-exemption state than a generic household; that is, its risk of moving to such a state is about 2% higher. The rest of the marginal effects are also reported in this table. It is perhaps most illuminating, however, to use these results to gauge the overall impact of the bankruptcy propensity on migration; this will give us a better idea of the economic significance of forum shopping. By setting the bankruptcy propensity to zero for all households, we can estimate that the number of moves by U.S. households to higherexemption states would drop by about 17,000 per year. Although not insubstantial, it is quite modest relative to the total number of moves to higher exemption states each year (1.4 million), or the number of bankruptcies (1 million). By way of comparison, these are roughly the numbers one would obtain for welfare-induced migration by applying 19

20 the estimation results of Meyer (1998) to the welfare participation rates in effect from (the time period of his study). Finally, note that although the coefficient on the bankruptcy propensity is statistically significant in the lower level of the nested logit, this is not the case for the unconditional marginal effect. This may be interpreted as suggesting that while a household at risk for bankruptcy may indeed choose a high-exemption state should it find itself moving, it is unlikely to actually move state, which is consistent with the arguments of Sullivan, Warren and Westbrook (1989) and Gropp, Scholz and White (1997) discussed above. 6. Concluding Remarks In this paper we have presented evidence that while interstate migration takes place for the purpose of pre-bankruptcy planning, this effect is economically modest. We do this while carefully controlling for endogenously induced filing by using filing propensities rather than actual filing events as the covariate. This paper thus makes a contribution to the policy debate surrounding the proposed reform in the U.S. Bankruptcy Code by suggesting, first of all, that on the Federal level legislators need not be overly concerned with differences in exemptions across states. Similarly, our results also suggest that States should focus on the effects of exemptions on their own populations, rather than on potential immigrants (or emigrants). In addition, with the recent shift in European bankruptcy laws to a more American-style system characterized by the availability of a fresh-start, 37 and the increase in mobility expected within the European Union, bankruptcy forum-shopping may become a factor in these countries as well. Thus more research on forum-shopping, and on strategic behavior in bankruptcy in general, is certainly warranted. 20

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