The Changing Nature of Chapter 11

Abstract

The U.S. Chapter 11 bankruptcy system has long been viewed as debtor friendly, with frequency of absolute priority deviations (APD) in favor of equity holders commonplace, as high as 75%, before 1990. In the 1991-2005 period, we find a secular decline in the frequency of APD to 22%, with the frequency as low as 9% for the period 2000-2005. We identify the increasing importance of debtor-in-possession (DIP) financing and key employee retention plans (KERP) in bankruptcy as the key drivers of this secular decline. We also find management turnover in Chapter 11 has increased by 65% since 1990 and that APD are more likely when management has substantial share holdings in the firm. The time spent in bankruptcy has also declined from about 23 months before 1990 to 16 months after 2000. Collectively, these results are consistent with the thesis that Chapter 11 has increasingly become creditor friendly over the years. We discuss the implications of our results for models that assume that equity has a valuable dilatory option in the bankruptcy process.