Bankruptcy Resolution: Misery or Strategy

Event Date: 21 April 2021

Speaker: Jairaj Gupta (University of Birmingham)

Time: 2pm

Abstract:

In debt contracting literature, Capital covenants are known for their effectiveness in curbing agency issues, whereas violation of Performance covenants are known for triggering transfer of firms’ management control to lenders. Jointly, these covenant conditions are believed to curb agency problems and limit managerial opportunism. We expand this strand of literature by documenting the effectiveness of covenant conditions in curbing strategic bankruptcy filings, by investigating the role of financial benefits (excess of total liabilities over market value of total assets) in explaining firms’ likelihood of surviving bankruptcy under varying degrees of covenants bindingness. Bankruptcy emergence models build using a set of covariates relating to firm, judicial, case, geographic, and macroeconomic characteristics show that Chapter 11 bankruptcy survival rate is highest for firms that appear to have fully binding covenants than firms appearing to have partially or non- binding covenants. Factors affecting successful bankruptcy resolution also vary with the degree of covenants bindingness. Despite their highest survival rate, firms appearing to have fully binding covenants do not make strategic gains from bankruptcy filing unlike their non-binding counterparts. Contrary to the intuition, in presence of presumed non-binding covenants, firms with higher levels of financial benefits are more likely to file and emerge from Chapter 11 bankruptcy. This confirms that tighter covenant conditions curb strategic bankruptcy filings, thus limiting agency issues and managerial opportunism.

Published: 17 June 2021