Working Paper

REORGANIZATION OR LIQUIDATION: BANKRUPTCY CHOICE AND FIRM DYNAMICS

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%).

Keywords: bankruptcy laws; corporations; United States;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2017-06-13

Number: 17-14

Pages: 66 pages