The Disappeared Outperformance of Post-reorg Equity

Abstract

Using trading information of a comprehensive sample of relisted Chapter 11 firms in the past few decades, we find that the one-year market-adjusted buy-and-hold returns of post-reorg equity are over 50%. An equal-weighted calendar-time portfolio generates 7.2% annualized excess returns over a five-factor benchmark from 1992 to 2019. However, the outperformance concentrates in the 2000s, when institutional ownership of post-reorganization equity increased significantly. The positive post-emergence earnings announcement returns disappear in the most recent decade, and stocks of firms have better initial valuation after emergence. The evidence suggests that the outperformance of post-reorg equity documented in earlier studies is most likely due to market expectation errors for future earnings and thus initial undervaluation, which has been corrected in the recent period by sophisticated institutional investors.

Keywords: bankruptcy, stock returns, over-the-counter (OTC) market, earnings announcement, institutional ownership

JEL Classification: G11, G14, G3