Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics

66 Pages Posted: 19 Jun 2017

See all articles by Dean Corbae

Dean Corbae

University of Wisconsin - Madison

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia

Multiple version iconThere are 2 versions of this paper

Date Written: June 2017

Abstract

In this paper, we ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. Using Compustat data, we first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, we then estimate parameters of a firm dynamics model with endogenous entry and exit to include both bankruptcy options in a general equilibrium environment. Finally, we evaluate a bankruptcy policy change recommended by the American Bankruptcy Institute that amounts to a “fresh start” for bankrupt firms. We find that changes to the law can have sizable consequences for borrowing costs and capital structure which via selection affects productivity (allocative efficiency rises by 2.58%) and welfare (rises by 0.54%).

Suggested Citation

Corbae, Dean and D'Erasmo, Pablo, Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics (June 2017). NBER Working Paper No. w23515. Available at SSRN: https://ssrn.com/abstract=2988736

Dean Corbae (Contact Author)

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

Pablo D'Erasmo

Federal Reserve Banks - Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

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