Consumer Response to Chapter 11 Bankruptcy: Negative Demand Spillover to Competitors

When financially distressed firms have overwhelming debts, a prominent option for survival is to file for Chapter 11 bankruptcy protection. We empirically study the effect of Chrysler’s Chapter 11 bankruptcy filing on the quantity sold by its competitors in the U.S. auto industry. The demand for competitors could increase because they may benefit from the distress of the bankrupt firm (competitive effect). By contrast, competitors could experience lower sales if the bankruptcy increases consumer uncertainty about their own viability (contagion effect). A challenge to measuring the impact of bankruptcies is the coincident decline in economic conditions stemming from the Great Recession and the potential effect of the “cash for clunkers” program (among other confounding factors). To identify the effect of the bankruptcy filing, we employ a regression-discontinuity-in-time design based on a temporal discontinuity in treatment (i.e., bankruptcy filing), along with an extensive set of control variables. Such a design is facilitated by a unique data set at the dealer–model–day level that allows us to compare changes in unit sales in close temporal vicinity of the filing. We find that unit sales for an average competitor decrease by 28% following Chrysler’s bankruptcy filing. Several types of evidence suggest that this negative demand spillover effect is driven by a heightened consumer uncertainty about the viability of the bankrupt firm’s rivals. For example, we show that the sales of competitors’ vehicles that compete within the same segments as the bankrupt firm’s vehicles or that provide lower value for money are affected more negatively in response to the Chrysler filing. We also observe more web search activity for Chrysler’s competitors after the filing. Our findings are robust to different estimation strategies (global versus local), different functional forms, different estimation windows, the inclusion of various controls (e.g., “cash for clunkers,” incentives, advertising, inventory, recalls, price, and consumer confidence), the donut regression discontinuity approach, a potential serial correlation issue, a falsification exercise, and the inclusion of differential trends at various levels. Our study aims to inform policymakers and managers about unintended short-term demand consequences of Chapter 11 bankruptcy.