Pricing Expected Deviations from Absolute Priority in Bankruptcy

Abstract

We estimate pre-bankruptcy shareholders’ expected negotiating power using accounting information available at the bankruptcy filing. We find that the equity value on the day following the bankruptcy filing reflects theoretical determinants of priority violations. Specifically, the post-petition value of pre-bankruptcy shareholders’ claims on the bankrupt firms’ assets is positively related to the ratio of unsecured-to-secured debt, tax-loss-carry-forwards, and intangible asset value which would be lost in liquidation. Our results further suggest that the option to put leased assets back to the lessor increases shareholder power. Our results are (a) significant after controlling for firm size, financial health, and the likelihood of emergence; (b) not driven by multicollinearity in explanatory variables; and (c) robust to variation in post-bankruptcy equity valuation date.