Paths of Bankruptcy and Corporate · PDF fileKeywords: Bankruptcy; Liquidation; Restructuring;...

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Paths of Bankruptcy and Corporate Restructuring Michelle M. Harner Francis King Carey School of Law University of Maryland Baltimore, Maryland 21201 Email: [email protected] Phil Phan Carey Business School Johns Hopkins University Baltimore, MD, 21202 Email: [email protected] Xian Sun Carey Business School Johns Hopkins University Baltimore, MD, 21202 Email: [email protected] November 2013

Transcript of Paths of Bankruptcy and Corporate · PDF fileKeywords: Bankruptcy; Liquidation; Restructuring;...

Paths of Bankruptcy and Corporate

Restructuring

Michelle M. Harner

Francis King Carey School of Law

University of Maryland

Baltimore, Maryland 21201

Email: [email protected]

Phil Phan

Carey Business School

Johns Hopkins University

Baltimore, MD, 21202

Email: [email protected]

Xian Sun

Carey Business School

Johns Hopkins University

Baltimore, MD, 21202

Email: [email protected]

November 2013

Preliminary Draft

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Draft of November 1, 2013

2 © 2013 by Michelle Harner, Phillip Phan and Xian Sun.

Abstract

Most bankruptcy filings are voluntary. Firms continue to operate before and after emerging from

bankruptcy protection. However, we know little about how such reorganization decisions are

made and their effectiveness in ensuring firm survival. Not surprisingly, we believe that the role

of the Chief Executive Officer (CEO) matters and that the decision depends on her private

information. We posit that the nature of such information can be induced from the pattern of

CEO stock holdings prior to the bankruptcy event. In contrast to the extant research suggesting

that CEOs sold their stocks prior to the bankruptcy event, we argue that CEOs with positive

private information about the prospects of the post-bankruptcy firm would accumulate stock,

whereas those with negative information would sell them. We anticipate that the type of

bankruptcy (Chapter 9 or Chapter 11) would correlate with whether CEOs accumulate or unload

stock, and whether CEOs keep or lose their jobs. We show that CEOs anticipate bankruptcies

three years prior to the filing event. CEOs of firms the successfully emerge from bankruptcy

increased their stocks whereas those of unsuccessful firms started selling three years prior to the

event.

JEL classification: G33; G34

Keywords: Bankruptcy; Liquidation; Restructuring; Risk shifting; Executive compensation; CEO

turnover; Wealth redistribution; Post-bankruptcy performance

1. Introduction

As with the market for corporate control, the bankruptcy process eliminates inefficient firms for

resources to be re-deployed in the economy. However, in their seminal work, Jensen and

Meckling (1976) identify a major agency cost as the strategic redistribution of wealth from the

equity holders and bondholders to the CEO.1 This agency cost is amplified when firms are

financially challenged and managers take actions to protect their personal wealth. These actions

may include the reorganization of the firm through voluntary bankruptcy filings, which

according to the UCLA-LoPucki Bankruptcy Research Database (BRD) is about 96% of the

1 If the manager is also a significant equity owner, the agency costs between managers and equity holders are

reduced but not eliminated since the manager can how shift a disproportionate share of her risks to minority equity

holders.

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cases, in which a significant redistribution of wealth can occur (White, 1989). In fact, of all

large2 bankruptcy cases filed between 1980 and 2012 only 46% of the firms were liquidated or

merged while the rest continued to operate as independent entities, suggesting that managers

continue to exercise private control even when performance is poor.

The purpose of this study is to explain the role of the CEO in a firm’s decision to file a

voluntary bankruptcy proceeding and the outcomes of the decision. We test hypotheses derived

from agency theory to better understand what happens prior to and during a voluntary

bankruptcy proceeding. We look at the 3-year pattern of CEO stock ownership prior to the

bankruptcy event, the CEO’s wealth exposure to firm risk, window dressing behaviors, and the

reaction of the stock market to the bankruptcy event, given the pre-conditions.

A voluntary bankruptcy reduces shareholder scrutiny because the court freezes all claims

on the firm’s assets. This stay is supposed to allow CEOs time to reorganize the firm in order to

improve the productivity of its assets. Although a “successful” bankruptcy is difficult to

empirically define because the outcome depends on the particular circumstances motivating the

filing,3 conceptually a bankruptcy proceeding should not result in the reemergence of an

inefficient firm. However, we find this not to be the case. The BRD data shows that 23% of

reorganized firms failed in their first attempts at restructuring and had to re-file. Among these 65%

were ultimately liquidated, suggesting that the first attempt may not have gone far enough. More

seriously, when a voluntary bankruptcy allows CEOs to manage earnings, trade stock, and

negotiate prepackaged reorganization deals to secure their jobs, such window dressing results in

wealth redistribution from equity and debt holders to management.

2 Filing firms with assets worth $100 million or more, measured in 1980 dollars.

3 The definition of “success” in a Chapter 11 filing is widely debated. See, for example, Warren & Westbrook

(2009).

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Dyreng, Hillegeist and Penalva (2011) show that firms engage in earnings management

to avoid technical default. We examine the pattern of discretionary earnings management in the

years prior to a bankruptcy filing to measure the impact of financial information quality on

bankruptcy success. We hypothesize that when firms become more aggressive in earnings

management, i.e., window dress, prior to a bankruptcy filing, they are more likely to re-file after

emerging from the first reorganization (c.f., Wruck, 1990; Weiss and Wruck, 1998). We find

that managers indeed engaged in more earnings management activity to avoid default, the

average value of discretionary accruals (DAC)4 for all bankruptcy outcomes in the year prior to

the filing is 0.113, a significant increase from 0.091, three years prior. In liquidations, DAC

increased by about 41% from 0.098 to 0.139, significantly higher than the 13.6% increase for

reorganized firms. The evidence suggests that reorganized firms are less aggressive in earnings

management because CEOs want to minimize the risks to the emerged firm’s operational

capacity.

In theory, as primary driver of a firm’s strategies, a CEO has private information of the

firm’s current financial status and should have a well-informed estimate of the firm’s financial

future. As such, she may be able to anticipate the outcome of the bankruptcy even before

initiating the filing. One mechanism through which the CEO can utilize this information is to

trade her own stocks in the company prior to the bankruptcy filing to preserve personal wealth.

Therefore, we hypothesize that CEOs that expect a high likelihood of reorganization success will

not sell stock but instead accumulate them. We find that CEOs of the firms that eventually

reorganized actually increased their share holdings by about 36% during the three years prior to

4 Using the modified Jones model (Dechow et al., 1995)

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filing. The increase in holdings is a way to gain from the private benefits of control (Eckbo and

Thorburn, 2003) while simultaneously signal confidence in the future of the firm.

We expect that such incentives would be greater when a CEO’s wealth exposure to her

firm, as measured by delta, is high. The use of equity-based compensation has grown rapidly in

recent years (Murphy, 1999; Perry and Zenner, 2000). The average dollar change in the

S&P1500 CEOs’ wealth for a 1% change in stock is $600,000 and it is $ 496,000 for the CEOs

of the filing firms.5 Given the significant wealth exposure to stock prices, CEOs cannot sell all

of their shares before the bankruptcy filing without risking significant economic and job loss.

Even if common equity is wiped out in a bankruptcy,6 a CEO may still reap the private benefits

of control from a voluntarily bankruptcy filing such as job retention and the possible

rearrangement of equity claims in the reorganized firm. Additionally, the opportunity cost of

holdings those shares would be low given the significantly deteriorated financial performance.

Finally, we study how shareholders react to the bankruptcy filings and how equity value

changes after a bankruptcy plan is accepted by the courts. Consistent with the practical7 and

academic evidence (Ayotte and Morrison, 2009) our results show that shareholders react

negatively to bankruptcy filings. The level of shareholders’ negative reaction, however, varies

depending on their assessment on the firms’ economic value. The shareholders’ reactions to the

likelihood of different bankruptcy paths, though negative, are consistent with the economic

rationale that the least efficient firms should be liquidated while firms that are more efficient

continue to operate after restructuring. We show that the average market value of the

5 This value is measured at three years prior to the bankruptcy filing.

6 Mehran, Nogler and Schwartz (1998) show that at least 41% of CEOs were better off after liquidation (as opposed

to reorganization) because they owned stock in the company. They look at liquidations in which dividends were

made to shareholders, such as non-bankruptcy liquidations. 7 See, e.g., “Why People Buy Stock in Bankrupt Companies”, Bloomberg Businessweek, May 19

th, 2011.

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reorganized firms starts to increase after reorganization and recovers their pre-bankruptcy value

in about four years. The firms that later re-file did not experience any market value recovery

after reorganization.

In sum, our data suggest that CEOs possess unique insights on the likely outcomes of

bankruptcy as early as three years prior to the filing event. Not surprisingly, we find that CEOs

act on these insights to protect their personal wealth when the prospects of reorganization are

slim and when they are likely to be fired during the process. Our study suggests that the

prepetition conduct of management and creditors may pre-determine, in certain respects, the

success of the company’s bankruptcy reorganization. The remainder of the paper is organized as

follows: Section 2 reviews the relevant literature; Section 3 presents the summary of the data;

Section 4 presents the regression results of the likelihood of reorganization and refilling; Section

5 shows the results of the market value of the filing firms before and after bankruptcy; and

Section 6 concludes.

2. Literature Review

A company experiencing financial or operational distress has two primary bankruptcy

alternatives in the United States: it can liquidate all of its assets under Chapter 7 of the U.S.

Bankruptcy Code (Code) or reorganize its assets under Chapter 11 of the Code (Senbet and

Wang, 2010; Harner, 2008). A company seeking to reorganize generally works to restructure its

balance sheet—perhaps coupled with operational fixes—and with the goal of emerging from

bankruptcy as a going concern. That reorganization typically involves a new capital structure,

with new equity holders, and often a new management team. Alternatively, the company may

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sell all or substantially all of its assets under Chapter 11. In addition, when reorganization

efforts fail, the company may liquidate under Chapter 11 in some instances or convert its case to

a Chapter 7 liquidation case.

Regardless of what management ultimately may predict as the likely outcome, most

companies opt to commence a Chapter 11 case. The driving force behind this decision is the

identity of the party who controls the bankruptcy case (Harner, 2011). In a Chapter 7 case,

management is replaced with a bankruptcy trustee either appointed by the court or elected by

creditors. In a Chapter 11 case, management stays in control of the company’s assets, operations

and restructuring efforts, and the company operates as a debtor in possession or DIP (Dahiya,

John, Puri, and Ramirez, 2003). Although the court may appoint a Chapter 11 trustee for cause,

those appointments are rare (Alces, 2007). Accordingly, the DIP model is the norm in the

United States.

Chapter 11 of the Code strives to rehabilitate debtors and maximize value for creditors.

Recognizing the potential tension in these two goals, Congress codified committee representation

for creditors and, in certain circumstances, equity holders (Harner and Marincic, 2011).

Specifically, the Code mandates the appointment of a statutory committee of the debtor’s seven

largest unsecured creditors willing to serve on such committee. The statutory committee has a

variety of powers and duties, including investigating the debtor’s prepetition conduct and

operations, and assessing the debtor’s restructuring alternatives and any proposed plans of

reorganization or liquidation. The statutory committee acts a fiduciary for its beneficiaries.

In addition, other parties in interest, including secured creditors, labor unions, employees,

retirees, trade organizations, and governmental entities, generally have the right to appear and be

heard in the company’s Chapter 11 case. Of these constituencies, secured creditors often are the

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most active, and they may represent diverging interests from the debtor and even other creditors.

Secured creditors can include lenders offering post-petition financing or DIP financing to the

company, prepetition lenders, lessees, and taxing authorities. Some of these parties also may

have been actively involved in the company’s prepetition restructuring efforts.

A growing body of literature exploring the dynamics of the debtor-creditor relationship

suggests increasing creditor control in bankruptcy cases (Baird and Rasmussen, 2006; Ayotte

and Morrison, 2009; Skeel, 2003; Daniels and Triantis, 1995; Gilson and Vetsuypens, 1994).

Studies show that creditors are using prepetition debt covenants, DIP financing negotiations and

terms, and other aspects of the debtor-creditor relationship to influence management’s decisions

(Nini, et al., 2012; Ayotte, et al., 2013). Commentators debate the utility of this trend. Some

assert that increased creditor control is necessary to balance what many perceive as pro-

management provisions in the Bankruptcy Code and to discipline management (Skeel, 2004;

Hotchkiss and Mooradian, 1997). Others argue that increased creditor control is leading to more

sales and less reorganization in Chapter 11 cases (Miller and Waisman, 2005; Baird and

Rasmussen, 2003; LoPucki, 2003; Whitman, et al., 1993).

Creditor participation also can lead to management turnover either prior to or during the

Chapter 11 case. A company may agree to hire a Chief Restructuring Officer (CRO) as part of

its prepetition negotiations with creditors (Waisman and Lucas, 2008). Secured creditors

typically have at least a veto right or some input on the identity of the CRO. The company also

may agree to hire a CRO as a concession in creditor negotiations during a Chapter 11 case to

avoid the appointment of a Chapter 11 trustee. Similarly, studies show an increased likelihood

of management turnover in bankruptcy. For example, 48% of debtors in one study replaced their

CEO within two years of the bankruptcy filing (Bernstien, 2006), and 70% of the CEOs in

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another study were replaced within that same period (Ayotte and Morrison, 2009). As such, who

is or should be controlling a company’s Chapter 11 case remains open to debate and further

study.

3. Summary of the Data

We conducted our analysis with a merged sample from several databases. The detailed

information concerning firms’ bankruptcy filings comes largely from the UCLA-LoPucki

Bankruptcy Research Database (BRD). The BRD includes all bankruptcy cases filed between

1980 and 2012 by or against a debt group with assets of $100 million or more, measured in 1980

dollars. The data comes from the last 10-K filed with the Securities and Exchange Commission

prior to bankruptcy for the year ending not less than three years prior to the filing of the

bankruptcy case. The total number of cases included in the original database is 917. To be

consistent with the literature we excluded firms in financial services, giving us a sample of 808

cases. The filing firms’ financial data were collected from COMPUSTAT; and stock prices from

CRSP. We matched our sample with DealScan to identify each filing firms’ loan borrowings

before bankruptcy. In order to study CEOs’ trading behavior before filing, we collected CEO

stock ownership data from ExecuComp, which covers the S&P1500. We also manually verified

and collected CEO stock ownership data from the SEC (filing DEF14A) fir firms not in the

S&P1500. Univariate results were prepared by using our manually collected SEC CEO data, and

information from ExecuComp was also tested in the regression analysis to verify our collection

method.

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3.1 Summary Statistics

We identified the outcome of each of the filings, manually, according to the detailed

description given in the BRD. Figure 1 presents the distribution of each type of bankruptcy by

year. The trend shows that reorganization was a prevalent form of bankruptcy during the 80’s

and the early 90’s. Sales of assets through liquidation increased thereafter, especially during the

2000 recession. M&A generally has not been a leading exit strategy for bankruptcy. It was,

however, popular during the hi-tech bubble and burst and the 2008 financial crisis.

[Insert Figure 1 Here]

Figure 2 shows the distribution of bankruptcy by type and by industry. Most of the

bankruptcies filed during the sample period are from the manufacturing industry, followed by the

transportation, retail, and service industries. There is no significant difference in the types of

bankruptcy, though, across industries.

[Insert Figure 2 here]

Table 1 presents a summary of various case characteristics of the filings. As an initial

matter, about 96% of the filings were voluntary and only 15.7% had the intention to sell at the

time of filing. We manually divided the sample into reorganization, sales of assets, and M&As.

Specifically, according to the bankruptcy outcome coded in BRD, we define those that continued

to operate (with the same or different name) and that were confirmed to emerge without specific

codes as Reorganization; we define those that were acquired by or merged with other firms as

M&As; and last we group those that sold the majority of their assets through liquidation or piece

meal sale, and those that were confirmed not to emerge without specific codes as Sale of Assets.8

8 Note that in the bankruptcy literature, some studies consider M&As as reorganizations, too, because the filing

firm’s business continues. When merged or acquired, especially through bankruptcy, however, top managers are

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[Insert Table 1 Here]

Table1 shows that 54.1% of the firms that filed bankruptcy reorganize, compared to 31.6%

that liquidate by selling the majority or all of their assets. The remaining 14.3% exited through

M&As, and of those, 77.6% were strategic M&As.9 The average CEO retention rate during the

entire bankruptcy process was 56%, meaning about 44% of the incumbent CEOs were replaced

before the bankruptcy process was complete. The majority of the reorganized firms (70%)

retained their CEOs, which is significantly higher than the 32% (52%) retention rate of

liquidation (M&As).

The results of Table 1 also show that common shareholders had a representative in less

than one percent of the bankruptcy cases, and retirees had a representative in about 1.7% of cases,

suggesting that common shareholders and retirees do not have much direct influence in the

bankruptcy process. They may depend on other channels to maximize their rights, such as CEOs

for shareholders and non-bankruptcy pension protection laws for retirees. Furthermore, Table 1

also shows that about 9.9% of the filings were prepackaged and 18% were prenegotiated with

certain creditors. Lastly, 23.3% of the reorganized firms later re-filed. Table 2 summarizes firm

characteristics, including observations on the firms’ lending relationships and data on the firms’

assets, leverage, profitability, and discretionary accruals (DAC). Among the 808 filings, about

76% of the firms had outstanding loans in the three years prior to bankruptcy, 8% of which did

not refinance when the last loan expired. About 10% of those with outstanding loans had

covenant violations before the bankruptcy filing. Although the average total assets remained

usually replaced immediately. Because we are interested in how CEOs may utilize their influence and proprietary

information of their firms to influence the bankruptcy outcome and eventually maximize their interests including job

security, we separate pure reorganization from those M&As. 9 These data are not reported due to space constraints but are available from the authors.

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relatively stable in the three years prior to the filing, the average leverage increased and

profitability (measured by ROA) decreased significantly at t-1. In order to control for firm

characteristics outside of the bankruptcy stage and to increase the number of the observations,

we included firm characteristics at t-2 in the subsequent regression analyses.

[Insert Table 2 here]

In addition, to examine the impact of variations in earnings management, we measured

DAC prior to bankruptcy filings using the modified Jones model (Dechow et al., 1995). First we

estimated the following cross-sectional regression for each two-digit SIC code and year for the

entire Compustat sample:

TACCjt /TAjt-1= α1/ TAjt-1+β1(∆Salejt-∆RECjt)/ TAjt-1+ β2PPEjt/ TAjt-1 (1)

Where ΔSALEjt is the change in sales for firm j in year t; ΔRECjt is the change in accounts

receivable; and PPEjt is property, plant, and equipment for firm j at the end of year t. The

estimated coefficients from this equation are then used to compute DAC:

DACjt= TACCjt /TAjt-1− 1/ TAjt-1 − 1(∆Salejt−∆RECjt)/ TAjt-1− 2PPEjt/ TAjt-1. (2)

To measure the level of earnings management activities, following Bergstresser and

Philipon (2006), we captured the absolute value of DAC. Consistent with the literature that

managers increase earnings management to avoid default, the average DAC of those filing firms

at t-1 is 0.113, significantly increased from 0.091 at t-3.

Table 3 presents the summary of CEO characteristics. The results show that the fixed

component of CEO’s compensation, namely salary, increased across the board significantly at t-1

to 49.1% from 38.7%. Because firm performance deteriorates significantly near bankruptcy,

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CEOs may negotiate for less focus on performance-sensitive components such bonus and stock

grants in their annual compensation package during this period. Because of the CEO’s role in

voluntary filing, this increased salary component again suggests that they take proactive actions

to mitigate loss of personal wealth.

[Insert Table 3 here]

Delta is the sensitivity of the manager's wealth to the firm's stock price; it measures the

dollar gain or loss in the manager's wealth for a given change in the firm's stock price.

Specifically, we calculated delta following Guay (1999) and Core and Guay (2002), using the

Black-Scholes (1973) option valuation model as modified by Merton (1973) to account for

dividends. Note that Delta calculation stops at 2006 because detailed information on the options

granted to CEOs, including exercise price, maturity, and number of options issued, are obtained

from ExecuComp and only available through 2006. Stock volatility was estimated by using

daily stock information from the Center for Research in Security Prices (CRSP). The average

delta of our sample is 0.496 million at t-3 and significantly reduced to 0.145 million at t-1. We

note that the number of observations reduce at t-1 but the available data suggest that CEOs had

much less total wealth exposure to stock prices immediately prior to the bankruptcy filing, which

is more evidence to support the hypothesis that CEOs take proactive actions based on their

proprietary information and power to act on behalf of the company. This was true regardless of

the length of CEO tenure.

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3.2 Bankruptcy Paths

As the primary driver behind most firm policies, a CEO has the proprietary information of the

firm’s current financial status and a more informed estimation of the firm’s future performance.

It would be hard to develop a successful reorganization plan without the person who knows the

most about the firm. Figure 3 presents the distribution of the types of bankruptcy by whether the

CEO is retained during the filing period. It shows that when CEOs are retained during the entire

process, the reorganization rate is 70%, significantly higher than the 35% when CEOs left during

the process (see, Gilson, 1990 for an explanation). This pattern remains regardless of the CEO’s

tenure at the time of filing, though filing firms with seasoned CEOs have slightly higher chances

of reorganization than those with new CEOs.

[Insert Figure 3 Here]

The other parties who, at least in theory, should have an accurate and fairly complete

understanding of the firm’s financial condition are the firm’s creditors. Figure 4 presents the

bankruptcy outcome by the firms’ lending relationship before filing. Among those firms that

stopped refinancing with any bank before bankruptcy (“creditor run”), only 43% emerged to

operate after the bankruptcy, significantly lower than the 56% of those with ongoing lending

relationships. This result is consistent with our conjecture that creditors may choose to

discontinue the lending relationship based on their assessment of the firms’ financial status.

[Insert Figure 4 Here]

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Firms may obtain financing during the bankruptcy process and those loans are identified

as debtor-in-possession (DIP) loans by DealScan. The unreported figure shows that DIP loans

are associated with reorganization especially when the firms did not have any outstanding loans

at the time of filing, suggesting one of the goals of a DIP loan is to facilitate a smooth

reorganization. When we study the interaction by DIP loans and CEO retention, we find that

DIP lending does not impact the likelihood of reorganization significantly and it is the CEO

retention during the bankruptcy process that determines the patterns of bankruptcy paths. Figure

5 presents the types of bankruptcy by CEO retention and DIP.

[Insert Figure 5 Here]

These two most informed parties, however, have conflicts, which will likely be amplified

during a period of firm financial distress. We questioned how the presence of both parties might

impact the bankruptcy path chosen. In Figure 6, we dissect our sample further by the bankruptcy

outcome, CEO retention, and terminated lending. The pattern suggested by the lending

relationship as demonstrated in Figure 4 disappears when we split the sample further by whether

the CEOs were retained during the entire filing process or not. Specifically, when CEOs are

retained, about 70% of filing firms reorganize with or without a continued lending relationship.

Those firms with CEOs replaced during the filing process, on the other hand, are more likely to

end with a sale of assets, though those that also experienced a terminated lending relationship are

least likely to emerge (about 25%).

[Insert Figure 6 here]

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The overwhelming relationship between the choice of retaining CEOs and the bankruptcy

path suggests CEOs, as insiders with intimate knowledge of the firm, are more important and

influential in reducing information asymmetry during this significant yet complicated process

than outside stakeholders such as the creditors. Although CEOs are often the first to be criticized

for the failure of an organization, our analysis suggests that various parties depend on the CEOs

institutional knowledge in assessing the firm’s economic value if it continues to operate. These

results confirm that it would be incredibly useful to have insight into a CEO’s assessment of the

firm’s condition.

One mechanism through which the self-interested CEO might utilize her access to

proprietary information is to change her ownership stake in the company’s stocks before

bankruptcy so as to maximize her wealth. By analyzing the changes in the CEOs’ stock

ownership during the three years prior to the filing, we find that not all CEOs of the filing firms

sell off their shares significantly. In fact, CEOs of the eventually reorganized firms actually

increase their share holdings by about 36% from t-1 to t-3, where t is the filing year, perhaps to

signal their confidence in the future of the company (See Figure7).

[Insert Figure 7 here]

Furthermore, the evidence suggests that CEOs of those firms whose bankruptcy filing

ends with liquidation or M&As also do not always reduce their holdings. Figure 8 shows that

CEOs of the non-reorganized firms who were not retained during bankruptcy were most likely to

reduce their stock ownership in the years prior to the filing. Notably, this evidence suggests

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CEOs of the most-likely-to-fail firms anticipate, up to three years in advance, that their firm will

fail and that they will not be retained during the bankruptcy process.

[Insert Figure 8 here]

Although our data regarding CEOs’ trading behavior may seem contrary to the

conventional expectation that self-interested CEOs may start withdrawing their ownership when

anticipating a bankruptcy, the results are consistent with the changes in trends on how managers

are compensated. Particularly, the use of equity-based compensation has grown rapidly in recent

years (Murphy, 1999; Perry and Zenner, 2000). The average dollar change in the S&P1500

CEOs’ wealth for a 1% change in stock is $600,000 and it is $ 496,000 for the CEOs of the

bankruptcy filings firms.10

Given the significant wealth exposure to stock prices, CEOs can’t

dump all of their shares in the years before the bankruptcy filing without risking significant

losses (e.g. economic losses and job loss). Figure 9 presents the level of earnings management

by bankruptcy outcome. DAC increased the most, by about 41% from 0.098 to 0.139, when the

filing firm ends with liquidation of all assets, significantly higher than the 13.6% increase for

reorganized firms. The finding that reorganized firms conduct less earnings management may

indicate that those CEOs anticipated continuing operations and therefore avoided earnings

management that may have jeopardized operations post-bankruptcy.

[Insert Figure 9 here]

10

This value is measured at three years prior to the bankruptcy filing.

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Breaking down the earnings management sample further by whether CEOs are retained

during the process offers more insight. Figure 10 shows the results. First, unlike other

reorganized firms, firms with long-standing CEOs who replaced during the bankruptcy process,

had an average DAC of 0.104 at t-1, a 37% increase from 0.076 at t-3. It seems that CEOs of

those firms anticipated they would not be retained to manage the reorganized firms and therefore

conducted excessive earnings management before filing so as to maximize the total economic

value of their exit package (including shares, options, and bonus if any).

[Insert Figure 10 here]

Interestingly, the seasoned CEOs retained after the reorganization actually reduced the

level of earnings management before filing. Such patterns are more obvious for the seasoned

CEOs than for those more newly appointed. Similarly, the increase in earnings management is

more significant for the firms with newer CEOs before the asset sale or M&A deal is completed

(See Figure 11 and 12).

[Insert Figure 11 and 12 here]

Figure 13 shows that the increase in earnings management is more evident for firms

without bank loans in the three years prior to the bankruptcy filing, and especially for those with

terminated lending relationships. These data suggest that firms with terminated lending

relationships may increase earnings management due to less monitoring from long-term creditors.

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[Insert Figure 13 here]

Earnings management would be particularly harmful if managers use it to disguise the

severity of the firms’ financial problems in order to survive bankruptcy and continue operations.

Figure 14 shows that DAC of those reorganized firms that re-filed later almost doubled at t-1

from t-3 (increased from 6% to 12%), suggesting that the managers conducted more aggressive

earnings management before bankruptcy in order to increase the chance of reorganization.

Despite these firms’ significant efforts to survive, the reorganization arguably did not solve

large-scale inefficiencies, resulting in a subsequent bankruptcy.

[Insert Figure 14 here]

Given the apparent influence of CEOs due to their proprietary information and the pattern

of earnings management before filing, one may question the efficiency of the bankruptcy process

or the disclosure requirements and monitoring of firms outside of bankruptcy. Our analysis of

the BRD yields some other interesting findings. For example, we find that prepackaged (or

prenegotiated)11

filings are more likely to lead to reorganization (see Figures 15 and 16), retain

incumbent CEOs, and reach a confirmed plan sooner. Similarly, they are less likely to conduct

11

Although our results are similar for these two types of pre-arranged bankruptcies, they are technically different

concepts. A prepackaged bankruptcy typically involves the negotiation and solicitation of acceptances of the plan of

reorganization prior to the filing of the bankruptcy case (Thorburn, 2000; Tashjian, Lease, and McConnell, 1996).

In contrast, a prenegotiated bankruptcy involves some prebankruptcy agreement regarding the structure and terms of

the plan of reorganization, but the solicitation of acceptances of the plan (and perhaps even further negotiation

concerning its terms) is accomplished after the bankruptcy filing.

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more aggressive earnings management than those without any sort of pre-arrangement. Our

results, however, suggest that although prepackaged deals seem to speed up the process, and

discourage self-interested management activities, prepackaged filings are unfortunately

significantly associated with re-filing.

[Insert Figures 15, and 16, here]

Specifically, Figure 17 shows that about 30% of the reorganized firms with a

prepackaged plan re-file, compared to 22% of those without a prepackaged plan. We attribute

the increased failure rate of prepackaged plans to several related factors such as those plans

fixing the short- but not the longer-term economic or operational issues facing firms and

receiving less judicial and creditor scrutiny through the process. This finding is troubling to the

extent it allows inefficient firms to survive, temporarily, sometimes at the expense of stakeholder

value.

[Insert Figure 17 here]

4. Hypotheses Tests

In this section, we study the likelihood of reorganization and re-filing based on the agency theory

predictions related to the use of private information by the CEO. We do this using standard

linear likelihood regression models. Table 4 presents the estimation results regarding likelihood

of reorganization. The dependent variable is a dummy variable; it is “1” if a firm emerges as a

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continuing operation post bankruptcy. Model 1 includes all observations with available

information; Models 2 through 5 include those with borrowings in the three years prior to the

filing so we can study the lending relationship effects. Specifically, Model 2 includes all

variables except for CEO retention during the filing process; Model 3 adds the CEO retention

variable; Model 4 adds CEO’s stock ownership by using our manually collected data from the

SEC; and Mode 5 uses CEO data from ExecuComp.

[Insert Table 4 here]

All regression models include industry dummies and an indicator for recession to control

for industry effects and economic shocks. The results confirm our findings discussed above. In

sum, continued employment of seasoned CEOs during the entire bankruptcy process has a

positive and significant relationship with the likelihood of reorganization. Although results in

Model 2 suggest that a terminated lending relationship reduces the likelihood of reorganization

significantly, such relationship disappears after we control for CEO retention in Model 3.

Whether using our manually collected SEC data or ExecuComp data, we find that increases in

CEOs’ stock ownership before filing significantly corresponds with a higher likelihood of

reorganization. Furthermore, when data are available, we find that CEOs’ delta—i.e., their total

wealth exposure to the firm’s stock price—also corresponds with a higher likelihood of

reorganization. Consistent with the univariate results, changes in earnings management

negatively relates with reorganization and prepackaged and pre-negotiated plans increase the

likelihood of reorganization.

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The Table 4 variables yield several additional interesting observations. First, controlling

for the size of the filing firm by assets, we consistently find a positive correlation between the

number of employees and the likelihood of reorganization. Although more research is needed,

this suggests that social welfare concerns may affect bankruptcy court decision-making.

Secondly, non-bankruptcy pension laws reduce the likelihood of reorganization. These data

might suggest that because non-bankruptcy law protects pensions, pensioners are less vulnerable

and have less interest in the success of the reorganization. As a result, pension organizations that

advocate for reorganization may have less influence on the bankruptcy path, given other factors

controlled.

Next, we study the success of reorganization by running regression analyses on the

likelihood of re-filing. Table 5 shows the results with a Logit model and Table 6 shows a

Heckman selection model to control for the likelihood of reorganization first.

[Tables 5 and 6]

The results from Tables 5 and 6 suggest that although reorganized firms conduct less

earnings management than liquidated firms, those reorganized firms with significantly more

aggressive earnings management before filing are more likely to re-file later. Moreover, a

prepackaged plan increases the likelihood of both reorganization and subsequent re-filing.

5. Market Value Effects

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Lastly, we examine shareholder reaction to bankruptcy filings. According to the practical12

and

academic evidence (Ayotte and Morrison, 2009) that shareholders react unfavorably to any

bankruptcy filing regardless of the outcome, we hypothesize that the level of shareholders’

negative reactions, will vary with their expectations of the firms’ economic value.

First, we use a standard event study approach to study the shareholders’ reaction to the

bankruptcy announcement. Stock information, which comes from the CRSP database, must

include data for the 299 days prior to and 1 days after the announcement date so as to create a

255-day estimation window ending 4613

days prior to the filing date and 3-day event window for

the event study. Table 7 shows the summary statistics of the cumulative abnormal returns

(CARs) by quintile. Consistent with the literature, the average shareholder reaction is

significantly negative at 23% (meaning on the filing date, the company’s stock dropped by 23%

that could not be explained by market movement).

[Insert Table 7 here]

Table 8 shows the results of the OLS regression analysis. The dependent variable is

CARs. The results suggest that shareholders react even more negatively to bankruptcy filing

when their firms stopped refinancing recently and when their CEO reduced her holdings.

Although the bankruptcy outcome is uncertain at the time of filing, shareholders may be able to

predict the likelihood of reorganization utilizing the factors we have highlighted. We therefore

12

See, e.g., “Why People Buy Stock in Bankrupt Companies”, Bloomberg Businessweek, May 19th

, 2011. 13

This is to reduce any information leakage effects.

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include the predicted value of reorganization from our estimation model (shown in Model 2) to

explain the CARs data due to a bankruptcy filing. The evidence suggests that when the

likelihood of reorganization increases, shareholders react less negatively to the announcement.

The shareholders’ reactions to the likelihood of different bankruptcy paths, though negative, are

consistent with the economic rationale of bankruptcy that the least efficient firms will be

liquidated while more efficient firms may continue to operate after restructuring (see Li, 2013,

for an explanation).

[Insert Table 8 Here]

We also plot the trends regarding market value of equity by bankruptcy paths in Figure

18. It shows that the average market value of filing firms dropped significantly from $1,000

million to $200 million during the three-year window before bankruptcy. It starts to increase

after firms reorganize and they recover their pre-bankruptcy average value of $1,000 million in

about four years (see Kalay, Singhal, Tashjian, 2007, for a discussion). Those later re-filed firms,

however, did not experience any market value recovery after reorganization. Note that the equity

holders before bankruptcy are not necessarily those after reorganization. Figure 18 simply

provides evidence on whether the trend of the filing firms’ market value is consistent with

bankruptcy paths and does suggest that the old equity shareholders recover later.

[Insert Figure 18 Here]

6. Conclusion

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Most bankruptcy filings are voluntary with firms continuing to operate after emerging from

bankruptcy protection. We found that between 1980 and 2012, 54.1% of the firms that

voluntarily filed for bankruptcy reorganized themselves, compared to 31.6% that liquidated by

selling the majority or all of their assets. The remaining 14.3% exited through mergers and

acquisitions, among which 77.6% were strategic. Seventy percent of the reorganized firms

retained their CEOs during the filing process, significantly higher than the 32% retention rate for

those that liquidated or 52% that were acquired. This pattern remained regardless of the CEO’s

tenure at the time of filing. Yet, we know little about how the voluntary bankruptcy

reorganization decision is made and how effective it is in ensuring firm survival. Our study

suggests that most firms emerging from bankruptcy appear to succeed in their reorganizations

but that about 23.3% subsequently re-filed for bankruptcy. The latter were more aggressive in

earnings management and more likely to employ prepackaged bankruptcy plans.

Our study shows that CEOs behave in a way that indicates they anticipate the bankruptcy

filing and the outcome up to three years prior to filing. This suggests that CEOs act on private

information about the financial health of their firms. One way they do so is to trade their equity

holdings in the firm. In fact, CEOs of the firms that eventually reorganized significantly

increased their stock ownership prior to the filing. The act of exercise private control in this

matter serves to mitigate their personal portfolio risk and to send a positive signal to the market

regarding the economic future of their firms. Similarly, we found that the CEOs of the firms that

eventually liquidated were more likely to dispose of their shares during the three years prior to

the filing, especially when they expected to be fired before the completion of the bankruptcy

process.

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We also found that creditors were good monitors of firms’ financial performance and that

their lending decisions were predictive of an eventual bankruptcy filing. Among the 808 filings

we studies, about 76% of the firms had loans in the three years prior to bankruptcy, 8% of which

were not refinanced when the last loan expired. Among those firms that experienced a

terminated lending relationship before bankruptcy, only 43% emerged; significantly lower than

the 56% of those with an outstanding lending relationship. This result is consistent with our

hypothesis that creditors choose to discontinue a lending relationship based on their prior

knowledge of their clients’ financial status. We find that when CEOs were retained throughout

the bankruptcy proceedings, 70% reorganized regardless of whether they had an outstanding loan

at the time of filing.14

Those firms that terminated their CEOs during the process were more

likely to end with a sale of assets, with those experiencing a terminated lending relationship

(25%) being the least likely to successfully re-emerge.

The overwhelming statistical relationship between the choice of retaining CEOs and the

bankruptcy path suggests that CEOs are more important and influential than stakeholders such as

creditors in reducing information asymmetry during this complicated process. Although CEOs

are often the first to be criticized for the failure of an organization, our analysis suggests that

various parties depend on the CEO’s depth of knowledge in assessing the economic value of the

filing firm. These results also suggest that it is possible induce the probability of a bankruptcy

filing, apart from the standard financial analyses used to predict bankruptcies, by observing the

pattern of insider trades up to three years before the event.

14

Throughout our analyses, we control for the length of CEO tenure in the regressions. As illustrated in Figures 1

and 2, the length of CEO tenure appears less influential than other factors.

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Figure 1

Distribution by Year and Type

Figure 2

Distribution by Industry

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Figure 3

Bankruptcy Paths by CEO Exit

Figure 4

The Types of Bankruptcy by Creditor Run

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Figure 5

Bankruptcy Paths by CEO Retention and DIP

Figure 6

Bankruptcy Paths by CEO Exit and Creditor Run

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Figure 7

CEO Shares Change by the Types of Bankruptcy

Figure 8

CEO Shares Change by CEO Exit & Bankruptcy Path

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Figure 9

Earnings Management by Type

Figure 10

Earnings Management by CEO Exit and Bankruptcy Paths: Reorganization

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Figure 11

Earnings Management by CEO Exit and Bankruptcy Paths: Sale of Assets

Figure 12

Earnings Management by CEO Exit and Bankruptcy Paths: M&As

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Figure 13

Earnings Management by Creditor Run

Figure 14

Earnings Management by Re-file and CEO Tenure

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Figure 15

Bankruptcy Path Comparison: Prepackaged Plans

Figure 16

Bankruptcy Path Comparison: Prenegotiated Plans

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Figure 17

Re-file Comparison: Prepackaged Plans

Figure 18

Market Value of Equity: By Bankruptcy Paths

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Table 1

Summary of Case Characteristics

This table presents the summary statistics of the filing cases. The number of observations varies for some variables due to data availability. Variables are defined in

the appendix.

Variables Observations Mean Std. Dev.

Voluntary 808 0.959 0.198

SalesIntended 808 0.157 0.364

Reorganize 808 0.541 0.499

M&As 808 0.143 0.351

Sale of Assets 808 0.316 0.419

CEO Exit before Disposal 688 0.445 0.497

Trustee Request 808 0.078 0.268

Rep_Unsecured 808 0.175 0.380

Rep_CE 808 0.005 0.070

Rep_Retirees 808 0.017 0.131

PctUnion 808 0.111 0.227

Re-file 437 0.233 0.423

Prepackaged 805 0.099 0.299

Prenegotiated 805 0.180 0.385

Tort 808 0.073 0.260

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Table 2

Summary of Firm Characteristics

This table presents the summary statistics of the filing firms. The number of observations varies for some variables due to data availability. Variables are defined in the

appendix.

Variables Observations Mean Std. Dev. Min Max

Creditors in 3 Yrs 808 0.765 0.424 0 1

Creditor Run 808 0.063 0.243 0 1

Violation in 3 yrs 808 0.099 0.299 0 1

Total Assetst-1($mil) 579 2,001.558 6,687.059 0 103,914

Total Assetst-2($mil) 716 2,091.228 7,597.909 0 148,883

Total Assetst-3($mil) 719 1,988.852 8,424.180 0.714 186,192

Leverage t-1 578 1.060 0.533 0 6.152

Leverage t-2 715 0.851 0.411 0 6.159

Leverage t-3 719 0.805 0.439 0 7.712

Profitability t-1 578 -0.252 0.409 -4.291 0.522

Profitability t-2 715 -0.086 0.243 -4.753 0.617

Profitability t-3 719 -0.043 0.171 -2.441 0.604

DAC t-1 198 0.113 0.120 0 0.643

DAC t-2 343 0.105 0.128 0.0004 0.643

DAC t-3 345 0.091 0.109 0.0001 0.643

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Table 3

Summary of CEO Characteristics

This table presents the summary statistics of the CEOs of the filing firms. The number of observations varies for some variables due to data availability. Variables are

defined in the appendix.

Variables Observations Mean Std. Dev. Min Max

Chairmant-1 100 0.540 0.501 0 1

Age t-1 81 54.444 8.322 36 81

Salary/TC t-1 95 0.491 0.302 0.048 1

Salary/TCt-2 143 0.368 0.298 0 1

Salary/TCt-3 150 0.387 0.288 0.002 1

Delta t-1($mil.) 87 0.145 0.484 0 4.320

Delta t-2($mil.) 140 0.445 1.549 0.002 13.989

Delta t-3($mil.) 140 0.496 1.454 0.001 14.760

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Table 4

Logit Regressions: The Likelihood of Reorganization

The dependent variable is reorganization, referring to those filing firms that continued to operate (with the same of different name) after emerging from the bankruptcy.

Model 1 reports results for all observations and Models 2 to 5 for those filing firms with outstanding bank loans in the three years prior to the filing. Model 4 uses CEO

compensation data manually collected from SEC filings and Model 5 uses CEO compensation data retrieved from ExecuComp database. Variables are defined in the

appendix. Industry effects are included. *, **, and *** denote statistical significance at the 10%, 5%, and 1% levels.

All All with loans in the previous 3 years

Model 1 Model 2 Model 3 Model 4 SEC Model 5 ExecuComp

Constant -7.567***

(0.002)

-5.035**

(0.023)

-5.264**

(0.034)

-14.035

(0.170)

-37.648*

(0.059)

CEO Exit -1.064***

(0.000)

-1.183***

(0.000)

CEO Tenure 0.147**

(0.018)

0.084

(0.159)

0.108*

(0.100)

-0.276

(0.714)

0.211

(0.670)

SharesownedChg 1.349**

(0.030)

0.413**

(0.044)

∆DACt-1 1.107

(0.776)

-25.775*

(0.100)

Delta t-1 2.506**

(0.042)

Creditor Run -0.806**

(0.050)

-0.578

(0.206)

1.300

(0.487)

4.342

(0.461)

LnTAt-2 0.307**

(0.023)

0.126

(0.300)

0.188

(0.174)

0.056

(0.934)

0.592

(0.485)

Leverage t-2 -0.047

(0.875)

0.397

(0.195)

-0.031

(0.921)

6.302**

(0.044)

5.610

(0.520)

MtB t-2 -0.003

(0.475)

-0.005

(0.343)

-0.003

(0.480)

0.046

(0.852)

-2.276**

(0.048)

Profitability t-2 0.012

(0.978)

-0.137

(0.747)

-0.198

(0.680)

2.855

(0.487)

37.568

(0.177)

LogEmployees 0.193* 0.285*** 0.264** 1.107* Omitted

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(0.078) (0.007) (0.024) (0.084)

Pension Protected -0.417*

(0.094)

-0.457*

(0.061)

-0.498*

(0.060)

-0.461

(0.558)

-11.088**

(0.026)

Trustee 0.006

(0.988)

0.079

(0.848)

0.031

(0.946)

Omitted -11.071

(0.205)

Rep_Unsecured -0.180

(0.492)

-0.037

(0.886)

-0.061

(0.824)

-1.478*

(0.081)

1.169

(0.802)

Rep_CE 0.015

(0.991)

0.268

(0.827)

-0.098

(0.941)

Omitted Omitted

Rep_Retirees -0.236

(0.758)

-0.217

(0.747)

-0.235

(0.762)

2.683

(0.276)

5.605*

(0.094)

PctUnion 0.079

(0.874)

-0.127

(0.785)

0.023

(0.966)

0.222

(0.882)

-1.577

(0.676)

Prepackaged 0.611

(0.142)

0.995**

(0.013)

0.449

(0.310)

Omitted Omitted

Prenegotiated 1.101***

(0.000)

1.537***

(0.000)

1.259***

(0.000)

1.670*

(0.086)

-0.406

(0.877)

SalesIntended -2.204***

(0.000)

-1.872***

(0.000)

-2.210***

(0.000)

-2.507**

(0.048)

-13.697**

(0.030)

Tort 0.111

(0.783)

0.183

(0.642)

0.261

(0.535)

-0.133

(0.935)

Omitted

Recession -0.326

(0.159)

-0.256

(0.265)

-0.324

(0.196)

-1.833**

(0.036)

3.921

(0.169)

Hitech -0.810**

(0.020)

-0.564*

(0.086)

-0.795**

(0.033)

Omitted Omitted

Outstanding Loans 0.111

(0.694)

Industry Dummy Yes Yes Yes Yes Yes

Obs. 544 538 488 92 48

Pseudo R2 0.254 0.211 0.261 0.459 0.644

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Table 5

The Likelihood of Re-filing after Initial Reorganization

This table reports the likelihood of re-filing after reorganization. Variables are defined in the appendix. Industry effects are included. *, **, and *** denote statistical

significance at the 10%, 5%, and 1% levels.

Model 1 Model 2 Model 3 Model 4

Constant -14.726

(0.989)

-11.291

(0.986)

0.993

(0.481)

-16.565

(0.995)

Prepackaged 1.198***

(0.007)

0.600

(0.581)

3.115**

(0.048)

Prenegotiated 0.569*

(0.095)

1.756**

(0.036)

1.413

(0.125)

LnXdaysin -0.400***

(0.008)

Turn Manager -2.212***

(0.007)

∆DACt-1 6.873*

(0.077)

#ofLoansafterRe-file 0.068

(0.164)

0.072

(0.138)

0.204*

(0.096)

-0.442**

(0.017)

Delaware -0.724**

(0.017)

-0.686**

(0.022)

-3.260***

(0.001)

-0.476

(0.526)

CEO Exit 0.038

(0.909)

0.120

(0.726)

0.153

(0.849)

-0.012

(0.989)

Outstanding Loan -0.141

(0.696)

-0.189

(0.592)

-0.047

(0.964)

1.722

(0.155)

Tort -0.196

(0.744)

0.038

(0.950)

Omitted Omitted

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Industry Dummy Yes Yes Yes Yes

Observations 318 320 95 62

Pseudo R2

0.094 0.087 0.290 0.270

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Table 6

Heckman Selection Models: The Likelihood of Re-filing

This table reports the results of the likelihood of re-filing after reorganization using the two-stage Heckman

selection models. The dependent variable of the first stage is reorganization and the dependent variable of the

second stage is re-filing. Model 1 reports results for all observations and Model 2 for those filing firms with

outstanding bank loans in the three years prior to the filing. Variables are defined in the appendix. Industry effects

are included. *, **, and *** denote statistical significance at the 10%, 5%, and 1% levels.

All All with loans in the

previous 3 years

Model 1 Model 2

Re-file

Constant -1.073

(0.261)

-1.483***

(0.000)

Prepackaged 1.040*

(0.077)

0.884*

(0.060)

∆DACt-1 1.776

(0.160)

1.592*

(0.057)

#ofLoansafterReorganization -0.075

(0.277)

-0.075**

(0.013)

Delaware -0.200

(0.552)

-0.404***

(0.000)

Last CEO 0.094***

(0.000)

Select (Reorganize)

Constant -6.816***

(0.005)

-6.972***

(0.001)

CEO Exit -0.995***

(0.002)

-1.009***

(0.000)

CEO Tenure 0.044

(0.444)

0.030

(0.541)

Creditor Run -0.060

(0.882)

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TAt-2 0.389***

(0.001)

0.376***

(0.000)

Leverage t-2 -1.788***

(0.000)

-1.487***

(0.002)

MtB t-2 -0.002

(0.877)

-0.002

(0.828)

Profitability t-2 -0.086

(0.775)

-0.126

(0.672)

LogEmployees 0.123

(0.180)

0.151*

(0.074)

Pension Protected -0.392*

(0.092)

-0.444**

(0.021)

Trustee -0.416

(0.361)

-0.048

(0.911)

Rep_Unsecured -0.023

(0.927)

-0.071

(0.760)

Rep_CE -4.194

(0.996)

0.366

(0.697)

Rep_Retirees -0.557

(0.442)

-0.484

(0.481)

PctUnion 0.531

(0.248)

0.041

(0.926)

Prepackaged 0.536

(0.242)

0.345

(0.449)

Prenegotiated 0.646**

(0.023)

0.601**

(0.019)

Tort 0.451

(0.182)

0.720**

(0.013)

SalesIntended -1.137***

(0.000)

-0.893***

(0.001)

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Recession -0.703***

(0.005)

-0.615***

(0.004)

Hitech -1.356***

(0.002)

-1.346***

(0.001)

Outstanding Loans 0.003

(0.992)

Industry dummy Yes Yes

Obs 324 290

Censured Obs. 248 218

Rho 0.364 1.000

Chi2

0.51 4.43

Prob> Chi2 0.476 0.035

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Table 7

Summary of Announcement Effects

This table presents the three-day cumulative abnormal returns (CARs (-1, 1)) of the filing firms due to the bankruptcy filing. We use a standard event study approach to

study the shareholders’ reaction to the bankruptcy announcement. Stock information, which comes from the CRSP database, must include data for the 299 days prior to

and 1 days after the announcement date so as to create a 255-day estimation window ending 4615

days prior to the filing date and 3-day event window for the event

study.

Percentile CARs (-1,1)

Lowest -72.9%***

2nd

Quintile -40.0%****

3rd

Quintile -22.0%***

4th Quintile -5.8%***

Highest 26.1%***

Obs. 268

Mean -23.0%***

Stdv. 35.9%

15

This is to reduce any information leakage effects.

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48

Table 8

Regression Analysis of the Announcement Effects

This table presents the OLS regression results of the three-day cumulative abnormal returns due to the bankruptcy

filings. The dependent variable is CARs (-1, 1). Model 1 reports results for all observations and Models 2 to 4 for

those filing firms with outstanding bank loans in the three years prior to the filing. Model 3 uses CEO compensation

data manually collected from SEC filings and Model 4 uses CEO data retrieved from ExecuComp. *, **, and ***

denote statistical significance at the 10%, 5%, and 1% levels.

All All with loans in the previous 3 years

Model 1 Model 2 Model 3

SEC

Model 4

ExecuComp

Constant 0.043

(0.909)

-0.334***

(0.000)

2.851

(0.105)

4.309*

(0.079)

SharesownedChgt-1 0.306*

(0.078)

21.752***

(0.002)

Creditor Run -0.696**

(0.025)

-0.696**

(0.025)

0.263***

(0.010)

Delta t-1 -0.046

(0.620)

∆DACt-1 -0.035

(0.966)

-0.696

(0.447)

Rated 0.018

(0.725)

0.754**

(0.016)

0.445*

(0.097)

Pension Protected 0.003

(0.954)

0.377

(0.131)

-0.461*

(0.076)

TAt-2 -0.011

(0.554)

-0.237**

(0.020)

-0.154

(0.197)

Leverage t-2 -0.104

(0.172)

2.958*

(0.057)

-0.730

(0.472)

MtB t-2 -0.005

(0.751)

0.027

(0.804)

0.157*

(0.071)

Profitability t-2 0.105**

(0.031)

-0.396

(0.775)

1.445

(0.372)

IntangATt-2 0.175

(0.344)

-1.524*

(0.099)

-0.270

(0.781)

Rep_CE 0.830***

(0.000)

-0.369

(0.267)

omitted

Delaware -0.023

(0.659)

0.025

(0.876)

-0.576*

(0.068)

Prepackaged 0.227***

(0.002)

-2.885

(0.665)

5.613

(0.471)

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49

Prenegotiated 0.162*

(0.063)

-0.365

(0.148)

0.518*

(0.083)

Hitech -0.099

(0.247)

omitted -0.005

(0.993)

Recession -0.255

(0.117)

omitted

Outstanding Loans 0.036

(0.518)

Industry Dummy Yes Yes Yes Yes

Obs. 240 171 42 26

Adjusted R2

0.081 0.068 0.600 0.720

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50

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Appendix 1

Variable List

Name Description

Reorganization Those that continued to operate (with the same or different name)

and were confirmed to emerge without specific codes.

Sale of Assets Those that sold the majority of their assets through liquidation or

piece meal sale, and those that were confirmed not to emerge

without specific codes.

M&As Those that were acquired or merged by other firms.

Voluntary A case is "voluntary" if it was filed by the debtor.

SalesIntended Whether the debtor intend, at the time of filing, to liquidate all or

substantially all of its assets. CEO Exit before Disposal Whether CEO left the firm before a disposal is confirmed by the

court. Trustee Request It is a dummy variable and it is one when a Chapter 11 trustee was

requested. Rep_Unsecured It is a dummy variable and it is one when there was an official

committee appointed to represent the unsecured creditors.

Rep_CE It is a dummy variable and it is one when there was an official

committee appointed to represent the common stock.

Rep_Retirees It is a dummy variable and it is one when there was an official

committee appointed to represent retirees. PctUnion The percent of the number of union employees before bankruptcy.

Re-file Indicates whether if the reorganized company refiled bankruptcy.

Prepackaged A case is prepackaged if the debtor drafted the plan, submitted it to

a vote of the impaired classes, and claimed to have obtained the

acceptances necessary for consensual confirmation before filing

the case. Prenegotiated A case is prenegotiated if the debtor negotiates the plan with less

than all groups or obtains the acceptance of less than all groups

necessary to confirm before the bankruptcy case. Tort Indicates if bankruptcy is caused by tort debt such as product

liability claims or fraud claims. Creditors in 3 Yrs If the filing firm as outstanding loan (s) in the three years prior to

the bankruptcy. Creditor Run It is one when the filing firms discontinued borrowing loans in the

three years prior to the bankruptcy

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Violation in 3 yrs It is one when the filing firms with outstanding loans in the three

years prior to the bankruptcy experience covenant violation (s). Leverage The long-term debt to total assets ratio.

Profitability The net income to total assets ratio.

DAC Discretionary accruals, scaled by total assets at the beginning of

the year. We measure DAC using the modified Jones model

(Dechow et al., 1995). ∆DACt-1 The change in DAC in the year prior to the bankruptcy filing.

Chairmant-1 If CEO also holds the chairman position in the year prior to the

filing. Age t-1 The age of CEO in the year prior to the filing.

Salary/TC It refers to CEO salary, scaled by total annual compensation (TC).

TC is the CEO's annual total compensation and comes from

Compustat's TDC1 data item. It includes salary, bonus, the value

of option grants using the Black-Scholes formula, long-term

incentive plans, and other compensation. Delta ($mil.) It is the dollar amount of sensitivity of the CEO’s wealth

(including both options and common stock holdings) to a 1%

change in the value of the firm’s stock price in year t-1. CEO Tenure The log nature of the number of days the incumbent CEO at the

time of filing has become CEO. SharesownedChg The change in the number of common shares owned by CEO from

t-1 to t-3, where t is the filing year. MtB Market-to-book ratio.

Pension Protected Where the filing firms are incorporated in states with pension

protection laws for retirees. Recession Whether the firms file bankruptcy during economic recession

period. Recessions are identified following the NBER’s US

business cycles : http://www.nber.org/cycles.html. Hitech It is a dummy variable and it is one if the firm is in the hi-tech

industry defined by Chan et al. (1990). Outstanding Loans We identify if the filing firms have outstanding loans in the year of filing

by using DealScan data. LnXdaysin The log nature of the number of days from the filing date to the

bankruptcy plan confirmation date. #ofLoansafterRe-file The number of loans outstanding after reorganization.

Delaware Whether the filing firm is incorporated in Delaware.

Rated If the filing firm is rated by S&P.

IntangAT The intangible assets to total assets ratio.