February 26, 2006
Recent Work on Empirical Bankrupcty
Professor Larry Weiss has asked me to post the following annnouncements regarding some of his recent papers (one of which is to be presented at the upcoming Amercan Law and Economics Association meetings). Here they are:
1. For a review of the methodological problems of prediction bankruptcy using financial ratios, take a look at my paper with Vedran Capkun (on SSRN):
The Impact of Incorporating the Cost of Errors into Bankruptcy Prediction Models
The current methodology to use and evaluate default and bankruptcy prediction models is to determine their precision - the percentage of firms predicted correctly. In this study we develop a framework for incorporating Type I (the amount lost from lending to a firm which goes bankrupt) and Type II (the opportunity cost of not lending to a firm which does not go bankrupt) error costs into the prediction models and their evaluation.
Our results indicate that a lending model which accounts for the cost of errors and firm size yields higher profits than a model relying only on precision. This also supports our hypothesis that the usefulness of prediction models cannot be fully assessed independently of the costs of both types of forecast errors.
2. For a review of changes in the payouts in major bankruptcies, take a look at my paper with Vedran Capkun (on SSRN):
Bankruptcy Resolution: Priority of Claims with the Secured Creditor in Control
We present new evidence on the violation of priority of claims in bankruptcy using a sample of 222 firms that filed for Chapter 11 from 1993 through 2004. Our study reveals a dramatic reduction in violations compared to research on prior periods. These results are consistent with changes in court practices and laws transferring power to the secured creditors over our sample period. We also find an increase in the time from the date of filing to plan confirmation. Apparently, the potential benefits creditors receive from increased control over the process are mitigated by increased costs from a longer process.
3. To understand how putting the secured creditor in charge of bankruptcy cases impacts managers actions, take a look at my paper with Barry Adler and Vedran Capkun (on SSRN):
Bankruptcy Initiation In The New Era of Chapter 11
The bankruptcy act of 1978 placed corporate managers (as debtor in possession) in control of the bankruptcy process. Between 2000 and 2001 managers lost such control to creditors. This study examines financial ratios of firms filing for bankruptcy between 1993 and 2004 and tests the hypothesis that the change from manager to creditor control created or exacerbated managerial (and dominant creditor) incentive to delay bankruptcy filing. We find a clear deterioration in the financial conditions of firms filing after 2001, which suggests that managers may now postpone filings to avoid creditor control. We also observe patterns of operating losses and liquidations that suggest adverse economic consequences from such delay.
4. To see what happens to managers and board members when firms go bankrupt, take a look at my paper with Vedran Capkun (on SSRN):
Financial Distress and Corporate Control
We examine the replacement rates of directors and executives in 63 firms filing for bankruptcy during the 1995-2002 period. We find that over 76% of directors and executives are replaced in the four year period from the year prior to the bankruptcy filing through three years after. These rates are higher than in prior research. This is consistent with changes in bankruptcy procedures and practice (i.e. the increase secured creditor control over the process due to both DIP financing and changes in the Uniform Commercial Code) having a significant impact on the corporate governance of firms in financial distress.
February 26, 2006 | Permalink
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