Tax losses and bankruptcy emergence: evidence from US firms filing under Chapter 11

Purpose - This study aims to investigate the relationship between tax losses and the likelihood of emerging from bankruptcy procedures as reorganized entities, exploiting the exogenous shock provided by the 1997 Taxpayer Relief Act (TRA) in the USA. Design/methodology/approach - The empirical analysis uses a difference-in-differences approach and investigates a sample of US public firms filing under Chapter 11 bankruptcy procedures during the period 1984–2016. The analysis includes several robustness and endogeneity tests, including heterogeneous treatment effect analysis, entropy balancing and propensity score matching. Findings - The findings show that filing firms with higher tax losses are more likely to emerge from the procedure as reorganized firms. Further, this paper shows that firms with high tax losses reduced their likelihood of reorganization after the enactment of the 1997 TRA, as the new regulation reduced tax benefits related to losses. Additional analyses show that tax losses contribute to the reorganization of filing firms requiring more cash resources and restructuring efforts and they increase post-bankruptcy creditors’ recovery rates. Practical implications - This study informs policymakers, shareholders, creditors and other stakeholders that tax policy can facilitate business continuity within restructuring frameworks and preserve economic and social value. Originality/value - This study contributes to the literature on taxation and corporate restructuring with evidence that tax-loss policies incentivize reorganization during bankruptcy procedures. To the best of the authors’ knowledge, this is the first study to empirically demonstrate that tax losses influence the form of exit from bankruptcy procedures, adding to the set of firms’ features affecting bankruptcy emergence.