Bankruptcy Risk, Costs and Corporate Diversification

53 Pages Posted: 20 Jan 2012 Last revised: 24 Jan 2012

Date Written: November 17, 2011

Abstract

This paper studies the impact of diversification on firms that file for Chapter 11 bankruptcy. Prior research suggests that diversification affects both the probability and costs of distress. Treating bankruptcy as a special case of distress, we find that diversification reduces the likelihood of bankruptcy and liquidation in Chapter 11, which is consistent with the coinsurance hypothesis. However, we observe higher bankruptcy costs as measured by time spent in Chapter 11 and inefficient segment investment for diversified firms. Our evidence is consistent with the idea that diversification provides benefits to managers in terms of job security rather than to firms. Our findings may help firms to make diversification decisions and creditors determine lending policies toward different forms of organizations.

Keywords: Bankruptcy cost, Bankruptcy risk, Corporate diversification, Chapter 11

JEL Classification: G32, G33, G34

Suggested Citation

Singhal, Rajeev and Zhu, Yun Ellen, Bankruptcy Risk, Costs and Corporate Diversification (November 17, 2011). Journal of Banking and Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1362316 or http://dx.doi.org/10.2139/ssrn.1362316

Rajeev Singhal

Oakland University ( email )

Rochester, MI 48309-4401
United States

Yun Ellen Zhu (Contact Author)

Oakland University ( email )

419 Elliott Hall
Rochester, MI 48309-4401
United States

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