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Liquidation Versus Continuation: Did Reorganized Firms Do The Right Thing?

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    Abstract

    Bankrupt firms should reorganize if the wealth created by continuing is expected to exceed the wealth that would be created by liquidating. We examine 89 firms that reorganized in Chapter 11 and find that, despite having sub-standard accounting profitability, nearly 80% created more wealth by continuing rather than liquidating. Even firms that later completed second debt restructurings, on average, should not have liquidated the first time around. Cross-sectional results indicate that firms that complete prepackaged bankruptcies, emerge from bankruptcy with low debt ratios, retain their pre-bankruptcy CEOs, and firms that avoid second restructurings are more successful under our performance measure. Among high growth-option firms, those whose net investment exceeds their industry median create more wealth than firms whose net investment is less than their industry median. However, among low growth option firms, superior performance is found among firms that shrink relative to their industry.

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    Paper provided by Ohio State University in its series Research in Financial Economics with number 9512.

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    Handle: RePEc:wop:ohsrfe:9512

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    1. Robert Gertner & David Scharfstein, 1991. "A Theory of Workouts and the Effects of Reorganization Law," NBER Technical Working Papers 0103, National Bureau of Economic Research, Inc.
    2. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
    3. Gilson, Stuart C. & John, Kose & Lang, Larry H. P., 1990. "Troubled debt restructurings*1: An empirical study of private reorganization of firms in default," Journal of Financial Economics, Elsevier, vol. 27(2), pages 315-353, October.
    4. Eberhart, Allan C & Moore, William T & Roenfeldt, Rodney L, 1990. " Security Pricing and Deviations from the Absolute Priority Rule in Bankruptcy Proceedings," Journal of Finance, American Finance Association, vol. 45(5), pages 1457-69, December.
    5. Mooradian, Robert M, 1994. " The Effect of Bankruptcy Protection on Investment: Chapter 11 as a Screening Device," Journal of Finance, American Finance Association, vol. 49(4), pages 1403-30, September.
    6. Opler, Tim C & Titman, Sheridan, 1994. " Financial Distress and Corporate Performance," Journal of Finance, American Finance Association, vol. 49(3), pages 1015-40, July.
    7. Michael C. Jensen, 1991. "Corporate Control And The Politics Of Finance," Journal of Applied Corporate Finance, Morgan Stanley, vol. 4(2), pages 13-34.
    8. Kaplan, Steven N., 1994. "Campeau's acquisition of Federated : Post-bankruptcy results," Journal of Financial Economics, Elsevier, vol. 35(1), pages 123-136, February.
    9. Kaplan, Steven N., 1989. "Campeau's acquisition of federated : Value destroyed or value added," Journal of Financial Economics, Elsevier, vol. 25(2), pages 191-212, December.
    10. Alderson, Michael J. & Betker, Brian L., 1995. "Liquidation costs and capital structure," Journal of Financial Economics, Elsevier, vol. 39(1), pages 45-69, September.
    11. Harris, Milton & Raviv, Artur, 1990. " Capital Structure and the Informational Role of Debt," Journal of Finance, American Finance Association, vol. 45(2), pages 321-49, June.
    12. Brian L. Betker, 1995. "An Empirical Examination of Prepackaged Bankruptcy," Financial Management, Financial Management Association, vol. 24(1), Spring.
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    Cited by:
    1. Bandopadhyaya, Arindam & Jaggia, Sanjiv, 2001. "An analysis of second time around bankruptcies using a split-population duration model," Journal of Empirical Finance, Elsevier, vol. 8(2), pages 201-218, May.
    2. Pulvino, Todd C., 1999. "Effects of bankruptcy court protection on asset sales," Journal of Financial Economics, Elsevier, vol. 52(2), pages 151-186, May.

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