Regulatory Protection and Opportunistic Bankruptcy

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See all articles by Radhakrishnan Gopalan

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School

Xiumin Martin

Washington University in Saint Louis - Olin School of Business

Kandarp Srinivasan

Northeastern University - D’Amore-McKim School of Business

Date Written: September 14, 2022

Abstract

We document controlling shareholder (insider) opportunism in an insolvency regime that uses an accounting rule to determine bankruptcy eligibility. Our study sheds light on managerial incentives induced by weak investor protection laws. Using unique data on bankrupt firms from an emerging market, consistent with our prediction, we show insiders intentionally manage earnings downward to understate firm net worth so as to be able to file for bankruptcy. Downward pre-bankruptcy earnings management is associated with more payments to insiders and weaker performance, post-filing. A battery of tests suggests our results cannot be fully explained as an artifact of financial distress. Rather, they are consistent with insiders exploiting weak investor protection to extract private benefits at the expense of lenders and outside shareholders. Our study serves as a cautionary tale for all insolvency regimes that use a balance sheet test in an environment with weak creditor protection.

Keywords: creditor rights, bankruptcy, net worth, opportunism, earnings management, private benefits

Suggested Citation

Gopalan, Radhakrishnan and Martin, Xiumin and Srinivasan, Kandarp, Regulatory Protection and Opportunistic Bankruptcy (September 14, 2022). Contemporary Accounting Research, Forthcoming, Available at SSRN: https://ssrn.com/abstract=

Radhakrishnan Gopalan

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
Campus Box 1133
St. Louis, MO 63130-4899
United States

Xiumin Martin

Washington University in Saint Louis - Olin School of Business ( email )

Saint Louis, MO 63130
United States

Kandarp Srinivasan (Contact Author)

Northeastern University - D’Amore-McKim School of Business ( email )

360 Huntington Ave.
Boston, MA 02115
United States

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