Bankruptcy Decision Making: An Empirical Study of Continuation Bias in Small-Business Bankruptcies

Edward R. Morrison

Journal of Law & Economics, 2007, vol. 50, pages 381-419

Abstract: Many small businesses attempt to reorganize under Chapter 11 of the U.S. Bankruptcy Code, but most are ultimately liquidated instead. Little is known about this shutdown decision. It is widely suspected that the bankruptcy process exhibits a continuation bias, allowing failing businesses to linger under the protection of the court, which resists liquidation even when it is optimal. This paper examines the shutdown decision in a sample of Chapter 11 bankruptcy cases filed in a typical bankruptcy court over the course of a year. The presence of continuation bias is tested along several dimensions—the extent of managerial control over the bankruptcy process, the accuracy and speed with which viable and nonviable businesses are distinguished, and the characteristics of the hazard of shutdown compared with the predictions of a formal model. Contrary to conventional wisdom, the paper finds that continuation bias is either absent or empirically unimportant.

Date: 2007
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