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Reorganization Or Liquidation: Bankruptcy Choice And Firm Dynamics

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  • Dean Corbae
  • Pablo D'Erasmo

Abstract

In this paper, we ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. Using Compustat data, we first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, we then estimate parameters of a firm dynamics model with endogenous entry and exit to include both bankruptcy options in a general equilibrium environment. Finally, we evaluate a bankruptcy policy change recommended by the American Bankruptcy Institute that amounts to a \fresh start\" for bankrupt _rms. We find that changes to the law can have sizable consequences for borrowing costs and capital structure, which via selection affects productivity (allocative effciency rises by 2:58%) and welfare (rises by 0:54%).

Suggested Citation

  • Dean Corbae & Pablo D'Erasmo, 2017. "Reorganization Or Liquidation: Bankruptcy Choice And Firm Dynamics," Working Papers 17-14, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:17-14
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics
      by Christian Zimmermann in NEP-DGE blog on 2017-07-08 01:51:40

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    4. Michael L. McIntyre, 2022. "Capital structure in an option-theoretic setting," SN Business & Economics, Springer, vol. 2(8), pages 1-24, August.
    5. Heller, Yuval & Peleg Lazar, Sharon & Raviv, Alon, 2022. "Banks’ risk taking and creditors’ bargaining power," Journal of Corporate Finance, Elsevier, vol. 74(C).
    6. Aili Zhang & Ping Chen & Shuanming Li & Wenyuan Wang, 2020. "Risk Modelling on Liquidations with L\'{e}vy Processes," Papers 2007.01426, arXiv.org.
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    8. Martin Kornejew & Chen Lian & Yueran Ma & Pablo Ottonello & Diego J. Perez, 2024. "Bankruptcy Resolution and Credit Cycles," NBER Chapters, in: NBER Macroeconomics Annual 2024, volume 39, National Bureau of Economic Research, Inc.
    9. Antill, Samuel & Grenadier, Steven R., 2019. "Optimal capital structure and bankruptcy choice: Dynamic bargaining versus liquidation," Journal of Financial Economics, Elsevier, vol. 133(1), pages 198-224.
    10. Wenyuan Wang & Xiang Yu & Xiaowen Zhou, 2021. "On optimality of barrier dividend control under endogenous regime switching with application to Chapter 11 bankruptcy," Papers 2108.01800, arXiv.org, revised Nov 2023.
    11. Nguyen, Duy Phat & Borovkov, Konstantin, 2023. "Parisian ruin with random deficit-dependent delays for spectrally negative Lévy processes," Insurance: Mathematics and Economics, Elsevier, vol. 110(C), pages 72-81.
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    17. Nishihara, Michi & Shibata, Takashi & Zhang, Chuanqian, 2023. "Corporate investment, financing, and exit model with an earnings-based borrowing constraint," International Review of Financial Analysis, Elsevier, vol. 85(C).
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    20. Satyajit Chatterjee & Burcu Eyigungor, 2020. "The Firm Size and Leverage Relationship and Its Implications for Entry and Business Concentration," Working Papers 20-29, Federal Reserve Bank of Philadelphia.
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    More about this item

    Keywords

    bankruptcy laws; corporations; United States;
    All these keywords.

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity

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