Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act
Boston University School of Management
Rainer F. H. Haselmann
University of Bonn
London Business School - Department of Finance
July 3, 2014
We study the effect of weakening creditor rights on distress risk premia via a bankruptcy reform that shifts bargaining power in financial distress toward shareholders. We find that the reform reduces portfolio- and firm-level risk factor loadings and returns of distressed stocks. The decline is higher for firms with lower firm-level proxies of shareholder bargaining power. Higher credit spreads for riskier over safer firms, in particular for firms with lower proxies of firm-level shareholder bargaining power, confirm a shift in bargaining power from bondholders to shareholders. Out-of-sample tests reveal that a reversal of some of the reform's effects (i.e., a decrease in shareholder bargaining power) leads to a reversal of risk factor loadings and returns of distressed stocks to levels similar to the pre-reform period. Thus, we document how creditor rights affect the costs of external funding; while weaker creditor rights are associated with higher credit spreads, they lead to lower equity premia.
Number of Pages in PDF File: 53
Keywords: financial distress, law and finance, shareholder recovery, stock returns
JEL Classification: G12, G14, G33, K39working papers series
Date posted: March 21, 2011 ; Last revised: July 4, 2014
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