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Financial Distress and Bankruptcy

Paper Session

Sunday, Jan. 7, 2018 10:15 AM - 12:15 PM

Loews Philadelphia, Lescaze
Hosted By: Association of Financial Economists & American Finance Association
  • Chair: Kose John, New York University

Destructive Creation at Work: How Financial Distress Spurs Entrepreneurship

Tania Babina
,
Columbia University

Abstract

Using US Census employer-employee matched data, I show that employer financial distress accelerates the exit of employees to found start-ups. This effect is particularly evident when distressed firms are less able to enforce contracts restricting employee mobility into competing firms. Entrepreneurs exiting financially distressed employers earn higher wages prior to the exit and after founding start-ups, compared to entrepreneurs exiting non-distressed firms. Consistent with distressed firms losing higher-quality workers, their start-ups have higher average employment and payroll growth. The results suggest that the social costs of distress might be lower than the private costs to financially distressed firms.

Selling Innovation in Bankruptcy

Song Ma
,
Yale University
Joy Tong
,
Duke University
Wei Wang
,
Queen's University

Abstract

We construct a comprehensive dataset of patent sales in Chapter 11 bankruptcies in all US public firms from 1981 to 2012. We document that 40% of firms sell, on average 18% of, their patents during bankruptcy reorganizations. Innovation sales concentrate in the first two quarters after bankruptcy filing. Firms sell more redeployable and liquid patents, as opposed to selling underexploited patents. This pattern is driven by firms that face "fire-sale" pressures and lack access to external financing. Our results suggest that imminent financing needs in bankruptcy drive innovation sales, and firms proactively avoid market trading frictions in the process.

When Do Firms Risk Shift? Evidence From Venture Capital

Matthew Denes
,
Carnegie Mellon University

Abstract

This paper studies the agency costs of debt and the role of risk shifting as firms face financial distress. The Small Business Investment Company (SBIC) program is a novel setting to evaluate the importance of these costs. It provides participating venture capital funds with debt financing from the U.S. government at a negligible premium to the 10-year Treasury Note. Economic mechanisms that might prevent risk shifting, such as covenants and reputation concerns, are primarily not present in this program. Using a difference-in-differences setting, I find that managers of distressed funds invest in firms with lower credit scores, sales, employment and patenting activity, and are more likely to use equity investments. Distressed funds reallocate capital to riskier firms in their portfolio, rather than searching for new investments. Equityholders respond positively to riskier investments for distressed funds and debtholder losses increase, consistent with the prediction that risk shifting transfers wealth from bondholders to equityholders.

Capital Market Competition and the Resolution of Financial Distress: Evidence from Corporate Bankruptcy Filings

Mahsa S. Kaviani
,
Temple University
Hosein Maleki
,
Temple University

Abstract

We study how credit market competition impacts the resolution of borrowers' distress. By exploiting positive shocks to competition in the banking industry, we document that higher competition leads to a significant decline in the rate of non-financial firms' bankruptcy filings. This decline predominantly stems from a sharp reduction in Chapter 11, as opposed to Chapter 7 filings. Changes in economic conditions, firm fundamentals or banks' preference for risk cannot explain the results. We show that fewer filings are driven by better bank monitoring, higher incentive to to avoid inefficient outcomes, and improved outcomes of private, pre-court workouts. Distressed firms also benefit from improved outcomes and fewer liquidations following a Chapter 11 filing, as well as shorter duration of the legal bankruptcy process.
Discussant(s)
Katherine Waldock
,
Georgetown University
Gordon Phillips
,
Dartmouth College
Erik Gilje
,
University of Pennsylvania
Edith Hotchkiss
,
Boston College
JEL Classifications
  • G3 - Corporate Finance and Governance
  • G2 - Financial Institutions and Services