CORPORATE BANKRUPTCY POTENTIAL, STOCKHOLDER RETURNS AND SHARE VALUATION

Abstract

CORPORATE BANKRUPTCY and the subsequent reorganization process is typically treated by academicians as an institutional problem of limited import. Yet, the appearance of these phenomena are conspicuous in numerous publicly held firms each year.' On the few occasions when bankruptcy is considered within a theoretic context, the analysis generally follows the argument that high levels of financial leverage increase the probability of bankruptcy which in turn decreases the value of that firm. This paper is concerned with the effect of potential corporate bankruptcy on expected shareholder wealth over time and therefore its effect on total firm share value. The present study differs from prior works in that a new framework is presented enabling, for the first time, empirical testing of the problem. The relationship between bankruptcy and valuation is briefly reviewed in Section I. Those works deemed most relevant to the problem are cited and evaluated. With this background, the suggested model is presented in general form in Section II. The following section outlines the empirical test and includes an explicit specification of the relevant variables. Section IV encompasses the presentation and analysis of the results and includes a discussion of their implications. The important findings are summarized in Section V.