The Dynamics of Debtor-in-Possession Financing: Bankruptcy Resolution and the Role of Prior Lenders

39 Pages Posted: 24 Jul 2000

See all articles by Sandeep Dahiya

Sandeep Dahiya

Georgetown University - Department of Finance

Kose John

New York University (NYU) - Department of Finance

Manju Puri

Duke University - Fuqua School of Business; NBER; FDIC

Gabriel G. Ramirez

Kennesaw State University - Michael J. Coles College of Business

Multiple version iconThere are 2 versions of this paper

Date Written: June 2000

Abstract

Debtor-in-Possession (DIP) financing is a unique form of financing that is allowed to firms filing under Chapter 11 of the US Bankruptcy Code. The legal provisions confer enhanced seniority on this financing. It is argued that such financing leads to excessive investment in risky, (even negative NPV) projects. Defenders of DIP financing, on the other hand, argue that it allows funding for positive NPV projects. We examine this issue empirically. Using a large sample of bankruptcy filings, we find little evidence of systematic overinvestment by firms that obtain DIP financing. The firms receiving DIP financing are more likely to emerge successfully and, on average, spend a shorter time in bankruptcy reorganization than the firms that do not receive such financing. Further, we find that relationships are important. In particular, when a lender with a prior lending relationship with the borrower is also the DIP lender, it is more likely to finance smaller firms. These firms also have a significantly shorter reorganization period than firms that secure DIP financing from a new lender. Our results suggest a positive role for DIP financing, which is strengthened when it is combined with a prior lending relationship with the firm.

Keywords: Chapter 11, Bankruptcy, Debtor-In-Possession Financing

JEL Classification: G33, G20

Suggested Citation

Dahiya, Sandeep and John, Kose and Puri, Manju and Ramirez, Gabriel G., The Dynamics of Debtor-in-Possession Financing: Bankruptcy Resolution and the Role of Prior Lenders (June 2000). AFA 2001 New Orleans; Presented at Tuck-JFE Contemporary Corporate Governance Conference. Available at SSRN: https://ssrn.com/abstract=236093 or http://dx.doi.org/10.2139/ssrn.236093

Sandeep Dahiya (Contact Author)

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States
202-687-3832 (Phone)

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

Manju Puri

Duke University - Fuqua School of Business ( email )

100 Fuqua Drive
Box 90120
Durham, NC 27708-0120
United States
919-660-7657 (Phone)

NBER

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

FDIC ( email )

550 17th Street NW
Washington, DC 20429
United States

Gabriel G. Ramirez

Kennesaw State University - Michael J. Coles College of Business ( email )

1000 Chastain Road
Kennesaw, GA 30144
United States
770-423-6181 (Phone)

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