Regulatory Protection and Opportunistic Bankruptcy
54 Pages Posted: 16 Oct 2015 Last revised: 18 Aug 2022
Date Written: June 1, 2016
We document controlling shareholder (insider) opportunism in an insolvency regime that uses an accounting rule to determine bankruptcy eligibility. Using unique data on bankrupt firms from an emerging market, we show insiders intentionally manage earnings downward to understate firm net worth so as to be able to file for bankruptcy. Downward pre-bankruptcy earnings management is associated with more payments to insiders and weaker performance, post-filing. A battery of tests suggests our results cannot be fully explained as an artifact of financial distress. Rather, they are consistent with insiders exploiting weak investor protection to extract private benefits at the expense of lenders and outside shareholders. Our study serves as a cautionary tale for all insolvency regimes that use a balance sheet test in an environment with weak creditor protection.
Keywords: bankruptcy, emerging markets, regulation, accruals, accounting rules, tunneling
JEL Classification: G33, M41
Suggested Citation: Suggested Citation