The Association between Bankruptcy Outcome and Price Reactions to Bankruptcy Filings

Abstract

This study investigates the association between bankruptcy outcome and the capital market's reaction to bankruptcy filings. Our sample consists of 77 firms that filed bankruptcy petitions between 1980 and 1996. We investigate whether, at the time of bankruptcy filing, the market differentiates between firms that are subsequently liquidated and firms that are subsequently reorganized. Our results indicate that liquidated firms have significantly larger negative price reactions at bankruptcy filing than reorganized firms. This result holds after controlling for a going-concern audit report in the period prior to bankruptcy filing, a technical or debt service default in the period prior to bankruptcy filing, firm size, prior Wall Street Journal announcement of a possible bankruptcy filing, firm financial condition, and other predisclosure information. Our findings suggest that the market has a high degree of insight into the subsequent bankruptcy resolution.