The Resolution of Corporate Distress Inside and Outside of the Courtroom

Abstract

This paper focuses on a theoretical well-worked area in corporate finance which however, lacks (at least) recent empirical evidence, namely the interaction between corporate distress and creditor concentration. We tackle this topic by providing a large sample evidence on the resolution of distress and distressed firms’ debt structure/concentration using a new database of publicly listed U.S. firms. We are able to analyze firms restructuring out-of-court and firms filing for formal bankruptcy procedure between 1999 and 2010. Our results suggest that both workout processes are efficient in generating sufficient information for an optim al liquidation versus reorganization decision thereby sorting efficient from ineffi cient firms. The feasible workout process depends on the concentration structure of debt, i.e. dispersed or concentrated. Financially distressed firms with concentrated debt can restructure out-of-court. Firms with dispersed debt have to undergo a formal bankruptcy procedure due to hold-out issues and thereby incur more distortion to their businesses. However, several Chapter 11 characteristics, such as prepackaging and DIP financing, speed up the procedure and thereby help financially distressed firms to emerge as reorganized from Chapter 11 rather quickly.