The Effect of Section 363 Sales on Recovery Rates: Allowing for Self-Selection Bias

Abstract:     
This paper empirically examines the determinants of bankruptcy resolution choce decision i.e. choice between section 363 (preplan) sales and traditional reorganization; the determinants of the availability and size of debtor-in-possession financing; and the effects of resolution choice on recovery rates. We find that business justification standard for not going though the traditional Chapter 11 process of disclosure and plan confirmation is not randomly applied - one can rather accurately classify companies according to their resolution choice. The resolution choice doesn't influence on the availability or on the magnitude of DIP financing. Predominant factor explaining difference in recovery rates relates to profitability prior to bankruptcy rather than to resolution choice itself. We find that section 363 sales are somewhere between "statistically significantly but not greatly worse" and "considerably but not statistically significantly worse". After controlling for self-selection (which is significant and effective), traditional reorganization does seem to offer higher recovery rates comparable to preplan sale, but results are neither statistically robust, nor as important as it is argued in LoPucki and Doherty (2007). Availability of DIP financing doesn't significantly affect recovery rates unless its size is considerable. The increase in relative size of DIP financing makes everyone better-off. Although results suggest that there is no systemic error with respect to companies that opt for preplan sales there are certainly several important procedural issues that could be improved while keeping the flexibility of section 363(b).

Keywords: Chapter 11, DIP financing, resolution choice, self-selection bias, section 363

JEL Classifications: G33, K22, G28

Working Paper Series