Forced conversion to Chapter 7 bankruptcy and optimal financial decisions

Hwa-Sung Kim

Finance Research Letters, 2023, vol. 54, issue C

Abstract: Empirical studies show that quite a few firms that initially filed for Chapter 11 were converted to Chapter 7 by bankruptcy judges, and that the conversion rate differs across judges. This study examines a firm’s optimal financial decisions when it is exposed to forced conversion. We find that forced conversion decreases shareholders’ incentives to invest and reduces the optimal leverage ratio. We show that equity risk after filing for Chapter 11 is more sensitive to forced conversion. When shareholders anticipate that forced conversion is more likely, the investment option value can be lower due to their opportunistic behavior.

Keywords: Bankruptcy judges; Chapter 7 liquidation; Chapter 11 reorganization; Optimal financial decisions (search for similar items in EconPapers)
JEL-codes: D81 G13 G31 J33 (search for similar items in EconPapers)
Date: 2023
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:54:y:2023:i:c:s1544612323000910

DOI: 10.1016/j.frl.2023.103717

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