Valuation of Bankrupt Firms

Abstract

This study compares the market value of firms that reorganize in bankruptcy with estimates of value based on management's published cash flow projections. We estimate firm values using models that have been shown in other contexts to generate relatively precise estimates of value. We find that these methods generally yield unbiased estimates of value, but the dispersion of valuation errors is very wide-the sample ratio of estimated value to market value varies from below 20% to over 250%. Cross-sectional analysis indicates that the variation in these errors is related to empirical proxies for claimholders' incentives to overstate or understate the firm's value. Relevant factors include the relative bargaining strength of competing (senior vs. junior) claimholders, management's equity ownership, the existence of outside bids to acquire or invest in the debtor, and senior management turnover.

See also the related papers "Information Effects of Spin-offs, Equity Carve-outs, and Targeted Stock Offerings" by Stuart Gilson, Paul Healy, Christopher Noe, and Krishna Palepu; and "Junk Bonds, Bank Debt, and Financing Corporate Growth" by Stuart Gilson and Jerold Warner

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JEL Classification: G31, G33, G34, K22