The Changing Nature of Chapter 11

Abstract

The U.S. Chapter 11 bankruptcy system has long been viewed as equity friendly, with absolute priority deviations (APD) in favor of equity holders occurring as often as in 75% of the cases in the 1980s. By contrast, based on a more recent and much larger sample of bankruptcies from the period 1991-2005 we document an average frequency of APDs of only 22%. Moreover, we find a secular decline in the frequency of APDs over our sample period. The time spent in bankruptcy has also declined steadily, from 23 months in the 1980s to 16 months after 2000. We argue and find evidence that innovations in the bankruptcy process, such as reliance on debtor-in-possession (DIP) financing and adoptions of key employee retention plans (KERPs) help explain this secular decline. We also find that APD are more likely when management has substantial share holdings in the firm. Collectively, these results suggest that Chapter 11 has become more creditor friendly in recent years.

Keywords: Bankruptcy, APR violations, Chapter 11

JEL Classification: G33, G34, G12