Chapter 14 - Bankruptcy and the Resolution of Financial Distress

Abstract

Bankruptcy law and related out-of-court mechanisms governing default on debt contracts form one of the essential building blocks of a private economy. The law provides a general structure that helps claimholders resolve unforeseen conflicts arising when the firm defaults on its debt payments. It also determines the allocation of control over the distressed firm to various claimholders and the extent to which market mechanisms are used in resolving financial distress. This chapter reviews empirical research on the use of private and court-supervised mechanisms for resolving default and reorganizing companies in financial distress. It presents a simple conceptual framework for analyzing financial distress that guides the organization of the empirical literature. It then summarizes and synthesizes the empirical research in the areas of financial distress, asset and debt restructuring, and highlights the features of the formal bankruptcy procedures in the United States and around the world. Furthermore, it reviews corporate governance issues related to the restructuring of financially distressed firms. It concludes by offering some comments and suggestions for the direction of future research.