Consumer Choice and Corporate Bankruptcy

Abstract

We estimate the indirect costs of corporate bankruptcy associated with lost customers. In incentivized experiments, randomly informing consumers about a firm’s Chapter 11 reorganization lowers their willingness to pay for the firm’s products by 18-35%. Up to 48% of consumers are aware of major bankruptcies. Using our experiments to estimate a structural model, we show that a Chapter 11 bankruptcy causally reduces a firm’s value by 10-31%, depending on the industry, through lost customers. We show that these costs are unlikely to arise before bankruptcy. Our results provide novel support for the tradeoff theory, a pillar of corporate finance.

Keywords: Consumer choice, bankruptcy, financial distress, structural estimation, experimental economics, Hertz

JEL Classification: D12, L15, G33