The Disappearing Outperformance of Post-reorg Equity

Abstract

Using trading information from both over-the-counter (OTC) markets and public exchanges of a comprehensive sample of relisted Chapter 11 firms in the past four decades, we find that newly issued equity from these firms outperforms industry- and characteristics-matched portfolios by 40--50% during the 200 trading days post emergence on average, but the median abnormal return is close to zero. The superior returns are almost exclusive to firms traded in the OTC markets. The equal-weighted calendar time portfolio generates 7.2% annualized excess returns over a five-factor benchmark, but the outperformance disappears in the recent decade. The post-emergence earnings announcement returns are positive only in the 2000s, when institutional ownership of post-reorganization equity increased significantly during the same time. The evidence suggests that the outperformance of post-reorg equity documented in earlier studies is likely due to market expectation errors for future earnings, which are corrected in recent periods by sophisticated institutional investors.