Does Limited Liability Stimulate or Stifle Innovation: Evidence from the US Bankruptcy Act of 1898

Innovation is a crucial driver for economic growth, but investment in innovation can also be risky. Limited liability can stimulate innovation by providing insurance against downside risk and stifle innovation if lenders reduce credit supply due to agency problems. In this study, I investigate how the passage of the first permanent federal bankruptcy code in 1898 affected innovation, particularly the quantity and quality of patenting activity by independent inventors in the United States. Using a difference in difference method, the study compares the change in patenting between states with pre-existing variation in statelevel bankruptcy codes, and different availability of homestead exemptions. I find a larger reduction in patenting in states with a more dramatic shift in limited liability. Further, the aggregated importance of the patents did not see a notable change, and for most cases, the average quality of the patents increased due to larger survival probability of highly potential projects.