Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act
Boston University School of Management; University of Illinois at Urbana-Champaign - College of Business
Rainer F. H. Haselmann
London Business School - Department of Finance
August 23, 2013
We study the effect of weakening creditor rights on stock returns via a bankruptcy reform that shifts bargaining power in financial distress towards shareholders. We find that the reform reduces portfolio- and firm-level distress premia of stocks. The decline in distress premia is smaller for firms with higher and with more substitutable firm-level proxies of shareholder bargaining power, which suggests a differential effect of the reform-based increase in shareholder bargaining power on stock returns. Higher bond yield spreads for riskier over safer firms and lower distress premia for stocks with deviations from absolute priority provide supporting evidence. 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 rise in distress premia to levels similar to the period before the reform. Thus, we document how creditor rights affect the costs of external funding; while weaker creditor rights are associated with higher bond yields, they can lead to lower equity premia.
Number of Pages in PDF File: 52
Keywords: financial distress, law and finance, shareholder recovery, stock returns
JEL Classification: G12, G14, G33working papers series
Date posted: March 21, 2011 ; Last revised: August 23, 2013
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