Which is better for distressed firms: Comparison between bankruptcy reorganization and major asset restructuring

Efficient institutional mechanisms play a pivotal role in guiding distressed firms through crises and preventing bankruptcy—thereby reducing unemployment, mitigating economic downturns, and stabilizing cyclical fluctuations. This paper examines two distinct institutional mechanisms for restoring the operating capabilities of financially distressed firms: one is major asset restructuring, which leverages the resource allocation functions of financial markets, and another is bankruptcy reorganization, which operates within a legal framework designed to balance the interests of diverse stakeholders. Our findings indicate that bankruptcy reorganization outperforms major asset restructuring in restoring the operating capabilities of financially distressed firms. This superior performance likely stems from better ability of bankruptcy reorganization to lower debt financing costs and enhance cash flow. However, some features inherent to bankruptcy reorganization—such as provisions allowing the transfer of shares to ordinary creditors for repaying debt—may hinder a distressed firm’s recovery. Further analysis reveals that strategic and bank investors tend to adopt a passive stance during bankruptcy reorganization.