IN SILICON VALLEY, running one or two startups into the ground is an essential step on an entrepreneur’s journey to success. For their European counterparts a single bankruptcy can derail a career. Being branded a failure once is all banks and other investors need to steer clear for ever. A new study shows the extent of the stigma a past failure can have on potential business-builders—and how it can be remedied.
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In the past, French public authorities often “flagged” top managers of firms that had gone bust for all to see. The blot featured prominently on records for three years and was readily available to banks, which used it to avoid once-failed managers. In 2013 the policy was changed: the flagging system was abolished, and the 143,000 erstwhile entrepreneurs informed of their newly cleaned slate. The overnight shift gave researchers a chance to see what impact the flagging system had had.
Christophe Cahn and Mattia Girotti of the Banque de France, which ran the bankruptcy database, along with Augustin Landier of HEC Paris, a business school, tracked the fortunes of the deflagged. In a paper in the Journal of Financial Economics they write that removing the stain of insolvency increased the probability of once-failed managers setting up a new business by at least 19%. Banks extended more credit and reduced the interest on some loans by nearly 0.5 percentage points.
The impact was largest for young founders with short records. More surprising, bankers seemed to be making decisions based on the information that was put in front of them by regulators. It is still possible—albeit a touch less convenient—for lenders to pull up details of a borrower’s past ventures. Once the information was out of immediate sight, few seemed to care.
The outcome is a vindication for French policymakers, who expressly wanted to encourage failed entrepreneurs to try again. About one in 40 managers were flagged at any one time, plenty of whom waited the three years until the stigma passed to have another go. Bankers, meanwhile, may want to dig into their borrowers’ histories: the study finds that a firm set up by a manager who had previously gone bust is nearly twice as likely to itself go under. Third time lucky?
This article appeared in the Business section of the print edition under the headline “Wiping the slate”
Source: Business - economist.com
