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Corporate Financial Distress and Bankruptcy: A Survey

Foundations and Trends in Finance, Vol. 5, No. 4 (2010) 243-335

81 Pages Posted: 5 Apr 2012 Last revised: 11 Jan 2013

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business

Tracy Yue Wang

University of Minnesota - Twin Cities - Carlson School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: July 2012

Abstract

This paper provides a synthetic and evaluative survey of issues in corporate financial distress and bankruptcy. This area has moved into a public domain as a result of the recent global financial crisis that witnessed failures of many venerable institutions that got rescued by the government. Hence, this survey highlights the resolution mechanisms not only in the private domain but also in the public domain, and it uses corporate finance paradigms to interpret some of the far-reaching developments in financial distress of systemic nature. This survey's theoretical anchor is a framework for the delineation of economic distress and financial distress. The difficulty in disentangling the dichotomy has been a central challenge in the empirics relating to financial distress, corporate bankruptcy, and the use of apparently cost-effective private mechanisms for resolving financial distress. This review devotes ample space on the discussion of conditions under which privatization of bankruptcy succeeds and fails, and the recent empirics on the subject. The review also grapples with the efficiency of bankruptcy codes and regimes, given the frequent usage of court-supervised mechanisms. The fundamental efficiency question about the bankruptcy law is whether the law effectively rehabilitates economically efficient but financially distressed firms and liquidates economically inefficient firms. This survey provides an ongoing debate in law and in economic theories about the efficiency of the US bankruptcy code. Moreover, it examines a linkage between financial distress and corporate governance, which has received growing attention. The review goes beyond the US to take a look at comparative bankruptcy codes around the world with a focus on bankruptcy reform issues in emerging economies. Finally, this survey takes us into a public domain and systemic financial distress. This is inspired by the recent global financial crisis. Is the standard bankruptcy procedure (e.g., those embedded in Chapters 11 and 7) sufficient for resolving systemic financial distress? The review attempts to answer this question in the context of the recently adopted landmark legislation, particularly the Dodd-Frank Act's Title II (Receivership), which governs the resolution of systemically critical institutions.

Keywords: financial distress, corporate bankruptcy, economic distress, systemic financial distress

JEL Classification: G21, G28, G32, G33, G38

Suggested Citation

Senbet, Lemma W. and Wang, Tracy Yue, Corporate Financial Distress and Bankruptcy: A Survey (July 2012). Foundations and Trends in Finance, Vol. 5, No. 4 (2010) 243-335. Available at SSRN: https://ssrn.com/abstract=2034646 or http://dx.doi.org/10.2139/ssrn.2034646

Lemma W. Senbet

University of Maryland - Robert H. Smith School of Business ( email )

College Park, MD 20742-1815
United States
301-405-2242 (Phone)
301-405-0359 (Fax)

Tracy Yue Wang (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

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