Abstract
An important strand of research on corporate bankruptcies via Chapter 11 in the United States has appropriately focused on the firm characteristics associated with emergence as viable business entities. This necessarily involves considering factors (such as management changes) that arise during the restructuring process. We consider a narrower question - which ex-ante factors are important in influencing the bankruptcy court’s decision in a Chapter 11 application: approval of the reorganization plan or dismissal culminating in the firm’s liquidation. We use a competing risks model and find that while financial attributes such as firm size matter, the formation of a creditors committee, debt prepackaging prior to filing, and judicial experience significantly impact the outcome as well as the duration of the legal process. The latter is important because it clearly influences the direct costs of bankruptcy and has also been used in the literature as a useful proxy for harder to measure indirect costs. We believe our approach which explicitly captures the time dimension provides a useful input to the cost-benefit considerations associated with a Chapter 11 filing.
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Notes
Prepackaging refers to cases where the debtor drafts a plan, submits it to a vote of the impaired classes, and purports to have the necessary acceptances before filing the case.
Economic applications include modeling of competing risks associated with unemployment (Katz and Meyer 1990), welfare spells (Blank 1989), mortgage terminations (Deng et al. 2000; Ciochetti et al. 2002), strategic acquisitions (Dickerson et al. 2003), corporate survival (He et al. 2010), and rent to own contracts (Anderson and Jaggia 2012).
Given independence between risks, these models are easily estimated as single-risk hazard models by treating completed transactions from other exits as censored at the point of completion (see Narendranathan and Stewart 1991).
See the website: http://lopucki.law.ucla.edu/ for details.
Total assets are measured in real terms (2014 dollars).
See Thomas (1996) for a detailed discussion.
This is unsurprising since we know from Table 1 that 605 out 657 (92.1%) were reorganized.
We should mention that the simulation results need to be interpreted with caution. We report and discuss the estimates in Tables 3 and 4, cognizant of the fact that these are based on the particulars of the simulation program. We therefore request the reader to treat our discussion in the context of broad economic magnitudes and directional findings while recognizing that the same data might yield slightly different estimates depending on the simulation protocol.
The bankruptcy cost literature is quite divided on the magnitudes involved (see Bris et al. 2006) but there appears to be a consensus that costs in dollar terms are positively correlated with firm size.
It is possible that in some jurisdictions, cases are not assigned randomly and that some discretion is exercised taking judicial experience into account. However, in our sample that does not appear to be the case. The correlation coefficient between firm size (as measured by the book value of total assets) and the judicial experience variable is statistically indistinguishable from zero.
Standard hazard models are inappropriate because they assume that the event of interest (reorganization) will eventually occur.
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Jaggia, S., Thosar, S. An evaluation of chapter 11 bankruptcy filings in a competing risks framework. J Econ Finan 43, 569–581 (2019). https://doi.org/10.1007/s12197-018-9458-6
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DOI: https://doi.org/10.1007/s12197-018-9458-6