Common Ownership and Bankruptcy

Abstract

Distressed firms and the banks that lend to these firms often have conflicting interests when going through the Chapter 11 process, freefall bankruptcy vs prepack bankruptcy. We examine whether common ownership, i.e., an institution with holdings in both the borrowing and the lending firms, ameliorates this conflict of interest. The results show that in the presence of common ownership, distressed firms are over 3.3-times more likely to file for Chapter 11 freefall bankruptcy (rather than prepack) compared to the case without a common owner. Using ownership of passive funds as an instrument for common ownership, we provide evidence of a causal relation between common ownership and bankruptcy filing choice. Overall, the analysis indicates that common ownership in both financially distressed borrowing firms and their lending firms leads to a greater likelihood of Chapter 11 freefall bankruptcy filing; suggesting that common owners typically side with creditors to maximize their combined equity value in both the borrowing and lending firm.

Keywords: Bankruptcy, Common Ownership, Corporate Governance, Institutional Ownership

JEL Classification: G33, G30, G34, G32