Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics

P. Dean Corbae and Pablo D'Erasmo

No 769, Working Papers from Federal Reserve Bank of Minneapolis

Abstract: In this paper, we ask how bankruptcy law affects the financial decisions of corporations and its implications for firm dynamics. According to current U.S. law, firms have two bankruptcy options: Chapter 7 liquidation and Chapter 11 reorganization. Using Compustat data, we first document capital structure and investment decisions of non-bankrupt, Chapter 11, and Chapter 7 firms. Using those data moments, we then estimate parameters of a general equilibrium firm dynamics model with endogenous entry and exit to include both bankruptcy options. Finally, we evaluate a bankruptcy policy change similar to one recommended by the American Bankruptcy Institute that amounts to a "fresh start" for bankrupt firms. We find that changes to the law can have sizable consequences for borrowing costs and capital structure which via selection affects productivity, as well as long run welfare.

Keywords: Corporate bankruptcy; Capital structure; Firm dynamics; Capital misallocation (search for similar items in EconPapers)
JEL-codes: E22 G30 G33 (search for similar items in EconPapers)
Pages: 65
Date: 2020-07-28
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-dge, nep-ent and nep-mac
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https://www.minneapolisfed.org/research/wp/wp769.pdf (application/pdf)

Related works:
Journal Article: Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics (2021)
Working Paper: REORGANIZATION OR LIQUIDATION: BANKRUPTCY CHOICE AND FIRM DYNAMICS (2017)
Working Paper: Reorganization or Liquidation: Bankruptcy Choice and Firm Dynamics (2017)
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedmwp:88447

DOI: 10.21034/wp.769

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