Indirect bankruptcy costs

This dissertation provides empirical evidence on the magnitude of indirect Chapter 11 costs. In the literature, some authors have presented evidence that the indirect costs of Chapter 11 bankruptcy are relatively large, while others have provided limited evidence that Chapter 11 indirect costs are not large and that Chapter 11 may provide some benefits to firms. Further, some legal and finance scholars argue that the firms that reorganize successfully are likely to have worst operating performance during the Chapter 11 period.; A potential explanation for the conflicting evidence on the magnitude of indirect bankruptcy costs is that some authors attribute poor firm performance in the prefiling period to the bankruptcy process biasing the magnitude of indirect bankruptcy costs upwards. Firms are expected to exhibit poor performance for a period of time before filing for bankruptcy. This dissertation separates poor firm performance and costs of financial distress from indirect bankruptcy costs and helps resolve the existing conflicting pieces of evidence.; The magnitude of the indirect bankruptcy costs is estimated as changes in abnormal operating performance of the sample firms during the Chapter 11 process. The sample firms experience poor performance and lose value as they approach bankruptcy filing. The sample firms are either reorganized, liquidated, or acquired in Chapter 11. The subsample of firms that reorganize successfully shows improvements both in operating performance and firm value during the Chapter 11 period. Analysis conducted using quarterly data indicates that both the liquidation and the acquisition subsamples experience insignificant changes in their operating performance during Chapter 11. Further analysis shows that there is insignificant difference between value changes for the reorganization firms and the liquidation and acquisition firms during Chapter 11. Prior research shows that at filing investors have imperfect information about the outcome of Chapter 11. Hence, similar changes in firm values during Chapter 11 for the reorganization and the liquidation and acquisition subsamples implies similar operating performance of the reorganization and the liquidation and acquisition subsamples. The evidence presented is consistent with the hypothesis that Chapter 11 provides net benefits to bankrupt firms and inconsistent with the hypothesis that chapter 11 performance of firms that reorganize is worse than that of firms that are liquidated or acquired.