Asymmetric information and conflicts of interest between equity and debt holders can force a distressed but efficient firm to liquidate and may enable a distressed inefficient firm to continue. In the extreme, if it is costless for an inefficient firm to mimic an efficient firm in a debt restructuring, efficient and inefficient firms are equally likely to continue or liquidate. This article shows that Chapter 11 procedures impose costs on inefficient firms that would otherwise mimic efficient firms. This separation induces voluntary filing for bankruptcy by inefficient firms and consequently enables efficient firms to continue when they would otherwise be liquidated.

Asymmetric information and conflicts of interest between equity and debt holders can force a distressed but efficient firm to liquidate and may enable a distressed inefficient firm to continue. In the extreme, if it is costless for an inefficient firm to mimic an efficient firm in a debt restructuring, efficient and inefficient firms are equally likely to continue or liquidate. This article shows that Chapter 11 procedures impose costs on inefficient firms that would otherwise mimic efficient firms. This separation induces voluntary filing for bankruptcy by inefficient firms and consequently enables efficient firms to continue when they would otherwise be liquidated.

Asymmetric information and conflicts of interest between equity and debt holders can force a distressed but efficient firm to liquidate and may enable a distressed inefficient firm to continue. In the extreme, if it is costless for an inefficient firm to mimic an efficient firm in a debt restructuring, efficient and inefficient firms are equally likely to continue or liquidate. This article shows that Chapter 11 procedures impose costs on inefficient firms that would otherwise mimic efficient firms. This separation induces voluntary filing for bankruptcy by inefficient firms and consequently enables efficient firms to continue when they would otherwise be liquidated.

This paper provides empirical evidence that takeovers can facilitate the efficient redeployment of assets of bankrupt firms. Bidders for bankrupt firms are generally in related industries and often have some prior relationship to the target, suggesting they are well informed with respect to both the value and best use of the target's assets. For a sample of 55 acquisitions in Chapter 11, we find that firms merged with bankrupt targets show significant improvements in operating performance, while matching non-bankrupt transactions show no significant improvement. We also find positive and significant abnormal stock returns for the bidder and bankrupt target at the announcement of the acquisition.Journal of Economic LiteratureClassification Numbers: G33, G34.

This paper examines whether mandatory auctions promote the efficient restructuring of distressed firms relative to a reorganization-based bankruptcy system such as Chapter 11. Under a mandatory auction system, aggressive bidding by a coalition of incumbent management and pre-bankruptcy creditors may deter outside bidders, may result in the coalition paying more than its valuation to acquire the firm, and may result in assets remaining in a lower value use. In a reorganization-based bankruptcy system, management's voluntary choice to seek an auction conveys information about the coalition's valuation, which facilitates competition. Our model shows that a reorganization-based bankruptcy system that encourages, but does not mandate auctions, can actually increase the likelihood that an outside bidder enters and the assets of the bankrupt firm are redeployed.

This paper investigates the role of vulture investors in the governance and reorganization of a sample of 288 firms that default on their public debt. The improvement in post-restructuring operating performance relative to the pre-default level is greater when the vulture investor becomes CEO or chairman or gains control of the target firm. We also find positive abnormal returns for the target's common stock and bonds in the two days surrounding the announcement of a vulture purchase of public debt or equity. Our evidence suggests that vulture investors add value by disciplining managers of distressed firms.

This paper examines asset sales by financially distressed firms. Contrary to the results for healthy firms, we find significantly lower returns to shareholders when asset sales proceeds are used to repay debt than when sales proceeds are retained by the firm. We find that asset sales proceeds are more likely to be paid out to creditors, as opposed to being retained by the firm, the larger the proportion of short-term senior bank debt in the firm's capital structure and the poorer the selling firm's investment opportunities. Our results suggest that creditors significantly influence the liquidation decisions of financially distressed firms.

This paper examines debt restructurings by financially distressed firms. We develop a model which predicts that, in public debt exchange offers, firms with unfavorable private information will offer equity claims to convince bondholders that the firm's prospects are poor. In contrast, offering equity to well-informed private lenders conveys favorable private information to outsiders. Consistent with our analysis, we find positive average abnormal returns around restructurings that offer equity to private lenders and senior debt to public debtholders, and we find significant negative average abnormal returns when private lenders are offered senior debt and public lenders are offered equity.

Hedge fund activists transfer relevant prior work experience to their activism campaigns. Categorizing activists based on past employment at investment banks (generalists), private equity or special situations partnerships (specialists), or other firms (nonfinancial experts), we relate activists’ prior work experience to their choices and outcomes. Both generalists with codifiable skills and specialists with tacit skills contribute to successful outcomes, but differences in these skills lead to differences in activism processes. Activist choices, market responses, target firm responses, and procedural aspects of activism vary with activist identity. Our analysis examines activists’ heterogeneous skills and highlights their importance in shaping activist interventions.