In 111 publicly traded firms that either file for bankruptcy or privately restructure their debt between 1979 and 1985, bank lenders frequently become major stockholders or appoint new directors. On average, only 46% of incumbent directors remain when bankruptcy or debt restructuring ends. Directors who resign hold significantly fewer seats on other boards following their departure. Common-stock ownership becomes more concentrated with large blockholders and less with corporate insiders. Few firms are acquired. Collectively, these results suggest that corporate default leads to significant changes in the ownership of firms' residual claims and in the allocation of rights to manage corporate resources.

This study investigates senior management turnover in financially distressed firms. In any given year, 52% of sampled firms experience turnover if they are either in default on their debt, bankrupt, or privately restructuring their debt to avoid bankruptcy. A significant number of changes are initiated by firms' bank lenders. Following their resignation from these firms, managers are not subsequently employed by another exchange-listed firm for at least three years. Results are consistent with managers experiencing large personal costs when their firms default.

ABSTRACT This study provides evidence that transactions costs discourage debt reductions by financially distressed firms when they restructure their debt out of court. As a result, these firms remain highly leveraged and one‐in‐three subsequently experience financial distress. Transactions costs are significantly smaller, hence leverage falls by more and there is less recurrence of financial distress, when firms recontract in Chapter 11. Chapter 11 therefore gives financially distressed firms more flexibility to choose optimal capital structures.

This study provides evidence that transactions costs discourage debt reductions by financially distressed firms when they restructure their debt out of court. As a result, these firms remain highly leveraged and one-in-three subsequently experience financial distress. Transactions costs are significantly smaller, hence leverage falls by more and there is less recurrence of financial distress, when firms recontract in Chapter 11. Chapter 11 therefore gives financially distressed firms more flexibility to choose optimal capital structures.

ABSTRACT This paper studies senior management compensation policy in 77 publicly traded firms that filed for bankruptcy or privately restructured their debt during 1981 to 1987. Almost one‐third of all CEOs are replaced, and those who keep their jobs often experience large salary and bonus reductions. Newly appointed CEOs with ties to previous management are typically paid 35% less than the CEOs they replace. In contrast, outside replacement CEOs are typically paid 36% more than their predecessors, and are often compensated with stock options. On average, CEO wealth is significantly related to shareholder wealth after firms renegotiate their debt contracts. However, managers' compensation is sometimes explicitly tied to the value of creditors' claims.

In May 1991, one month after seizing Executive Life, California regulators seized First Capital Life (FCLIC). Both insurers were Drexel clients with large junk bond holdings, and both had experienced ‘bank runs’. FCLIC's run followed regulators' televised comments that its poor condition necessitated a substantial cash infusion. Yet FCLIC's statutory capital — with junk bonds, real estate, and mortgages marked to market — was far from lowest among major insurers with California policyholders. It becomes lowest if junk bonds alone are marked to market at year-end 1990 (ignoring larger market declines in real estate/mortgages and the junk bond market's 21% return in early 1991). Our findings suggest a regulatory bias against junk bonds in the political backlash against the 1980s.

In April 1991, regulators seized the major subsidiaries of First Executive Corporation (FE), an insurer that invested heavily in junk bonds. During the junk bond market turmoil of 1989–1990, adverse publicity fueled a bank run at FE, forcing a $4 billion portfolio liquidation before the market rose 50–60% in 1991–1992. More traditional insurers did not receive commensurate press coverage, despite their substantial exposure to real estate declines, which were roughly 2.5 times the junk bond decline. Seizure of FE's subsidiaries was defensible, although FE would have become solvent within a year, given average junk bond market appreciation.

This study investigates the incentives of financially distressed firms to restructure their debt privately rather than through formal bankruptcy. In a sample of 169 financially distressed companies, about half successfully restructure their debt outside of Chapter 11. Firms more likely to restructure their debt privately have more intangible assets, owe more of their debt to banks, and owe fewer lenders. Analysis of stock returns suggests that the market is also able to discriminate ex ante between the two sets of firms, and that stockholders are systematically better off when debt is restructured privately.

This study compares the market value of firms that reorganize in bankruptcy with estimates of value based on management's published cash flow projections. We estimate firm values using models that have been shown in other contexts to generate relatively precise estimates of value. We find that these methods generally yield unbiased estimates of value, but the dispersion of valuation errors is very wide - the sample ratio of estimated value to market value varies from less than 20% to greater than 250%. Cross-sectional analysis indicates that the variation in these errors is related to empirical proxies for claimholders' incentives to overstate or understate the firm's value.