Entrepreneurs’ legal infractions and hidden information: Evidence from small business bankruptcies

We study how entrepreneurs’ attitudes toward risk, as measured by their personal legal infractions, are related to information asymmetry and agency problems prior to bankruptcy, using a sample of 260 small Swedish firms. We find that auditor resignations are more likely in firms where entrepreneurs have legal infractions. Furthermore, we find that legal infractions are negatively related to the likelihood of a firm disclosing its annual report and the quality of the bookkeeping, suggesting that information asymmetry problems are more severe when the entrepreneurs have legal infractions. We also find that creditors’ recovery rates in bankruptcy are lower if the entrepreneurs have legal infractions related to serious traffic offences, such as driving under the influence of alcohol or without a license.