Bankruptcy Claim Dischargeability and Public Externalities: Evidence from a Natural Experiment

Abstract

In 2009, the Seventh Circuit ruled in U.S. v. Apex Oil that certain types of injunctions requiring firms to clean up previously released toxic chemicals were not dischargeable in bankruptcy. This effectively increased the priority of cleanup obligations, requiring in many situations that they be met more fully before other creditors received payments. I show using difference in differences and triple difference methodologies that companies whose operations are confined to the Seventh Circuit (and thus likely to file for bankruptcy there) responded by reducing the volume of toxic chemicals they release on-site by approximately 12-30%. In place of these releases, firms substituted off-site treatment and disposal by specialized facilities generally considered to be safer for the environment. I also show evidence that many lenders to Seventh Circuit firms added stricter loan covenants governing toxic waste disposal following the decision. These results point to important ways in which bankruptcy law and other legal rules that impact recovery for firms' creditors can work to shape the positive or negative externalities those firms generate.

Keywords: Bankruptcy; Corporate Governance; Externalities; RCRA; Toxics Release Inventory

JEL Classification: G33, G34, G38, K22, K42, Q53, Q58, P48