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Bankruptcy Decision Making: An Empirical Study of Continuation Bias in Small-Business Bankruptcies

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  • Edward R. Morrison
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    Abstract

    Many small businesses attempt to reorganize under Chapter 11 of the U.S. Bankruptcy Code, but most are ultimately liquidated instead. Little is known about this shutdown decision. It is widely suspected that the bankruptcy process exhibits a continuation bias, allowing failing businesses to linger under the protection of the court, which resists liquidation even when it is optimal. This paper examines the shutdown decision in a sample of Chapter 11 bankruptcy cases filed in a typical bankruptcy court over the course of a year. The presence of continuation bias is tested along several dimensions—the extent of managerial control over the bankruptcy process, the accuracy and speed with which viable and nonviable businesses are distinguished, and the characteristics of the hazard of shutdown compared with the predictions of a formal model. Contrary to conventional wisdom, the paper finds that continuation bias is either absent or empirically unimportant.

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    File URL: http://www.journals.uchicago.edu/cgi-bin/resolve?id=doi:10.1086/511319
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    Bibliographic Info

    Article provided by University of Chicago Press in its journal The Journal of Law and Economics.

    Volume (Year): 50 (2007)
    Issue (Month): ()
    Pages: 381-419

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    Handle: RePEc:ucp:jlawec:v:50:y:2007:p:381-419

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    Web page: http://www.journals.uchicago.edu/JLE/

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    Cited by:
    1. Régis Blazy & Bertrand Chopard & Agnès Fimayer & Jean-Daniel Guigou, 2009. "Financial versus Social Efficiency of Corporate Bankruptcy Law: the French Dilemma?," Working Papers of BETA 2009-12, Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg.
    2. Blazy, Régis & Chopard, Bertrand & Fimayer, Agnès & Guigou, Jean-Daniel, 2011. "Employment preservation vs. creditors' repayment under bankruptcy law: The French dilemma?," International Review of Law and Economics, Elsevier, vol. 31(2), pages 126-141, June.
    3. Diana Bonfim & Daniel Dias & Christine Richmond, 2011. "What Happens After Default? Stylized Facts on Access to Credit," Working Papers w201101, Banco de Portugal, Economics and Research Department.

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