Valuation conflicts in corporate bankruptcy

Practitioners and scholars frequently criticize the existing approach to valuing firms in Chapter 11 bankruptcy, claiming incentive conflicts lead to biased value estimates that adversely affect pre-bankruptcy investment decisions and facilitate the continuation of inefficient firms. I address these claims by testing (i) whether negotiated estimates of bankrupt firms' equity value differ from intrinsic values; (ii) whether value estimates vary systematically as a function of claimant incentives, bargaining power, or other factors; and (iii) whether opportunistic valuations significantly affect either the division of estate value or debtors' post-bankruptcy performance. Using a sample of 104 firms that emerged from Chapter 11 from 1990 to 1997 with publicly traded shares, I find that value estimates approximate intrinsic values on average, but that valuation errors vary with participants' bargaining power and incentives to misrepresent value estimates, asset generalizability, and proxies for informational inefficiencies in the post-bankruptcy securities market. Evidence is weakly consistent with a real-option-based explanation of valuation errors. In addition, the ex-post costs of strategic valuation are nontrivial—significant wealth transfers occur as a result, and firms whose value estimates exceed intrinsic value tend to have worse post-bankruptcy operating performance than undervalued firms.