Are Longer Bankruptcies Really More Costly?
Daniel M. Covitz
Federal Reserve Board - Division of Research & Statistics
Federal Reserve Board - Division of Research and Statistics
Beth Anne Wilson
Government of the United States of America - Division of International Finance (IFDP)
FEDS Working Paper No. 2006-27
We test the widely held assumption that longer restructurings are more costly. In contrast to earlier studies, we use instrumental variables to control for the endogeneity of restructuring time and creditor return. Instrumenting proves critical to our finding that creditor recovery rates increase with duration for roughly 1½ years following default, but decrease thereafter. This, and similar results using the likelihood of reentering bankruptcy, suggest that there may be an optimal time in default. Moreover, the default duration of almost half of our sample is well outside the optimal default duration implied by our estimates. We also find that creditors benefit from more experienced judges and from oversight by only one judge. The results have implications for the reform and design of bankruptcy systems.
Number of Pages in PDF File: 48
Keywords: Bankruptcy cost, bankruptcy reorganization, recovery rate, credit risk
JEL Classification: G12, G14, G33, G34
Date posted: March 16, 2006