A Study of Bankruptcy Costs and the Allocation of Control*

Abstract

This article studies how the allocation of control rights in bankruptcy influences outcomes. Using Hungarian data, we find that the large majority of bankrupt firms in our sample are maintained as going concerns despite the fact that these firms generate large operating losses and low recovery rates for pre-bankruptcy creditors. We trace the bias to the allocation of control rights between secured and unsecured creditors and the compensation scheme of the agent managing the bankruptcy process. Our findings shed light on a very important bankruptcy design question: how particular provisions of the bankruptcy code affect the costs of bankruptcy and the size of the pie available to pre-bankruptcy creditors.