The choice between bankruptcy liquidation and bankruptcy reorganization: a model and evidence

Abstract

This paper proposes a two-period model to examine which bankruptcy procedure is better for both the debtor and creditor when insolvency happens. Our theoretical model depicts how firm size, industry characteristics, equity structure, and debt structure determine firms’ bankruptcy resolutions. Using a comprehensive sample of bankrupt firms in the United States, we verify the predictions of a theoretical model. In our study, we deploy Probit and Logit models to address the predictions in the theoretical framework and conduct a series of robustness checks with econometric methods like Propensity Score Matching to confirm the empirical results. This paper finds that firms with larger size have more chance to file for Chapter 11 reorganization when insolvency happens. We also find that firms in asset-heavy (asset-light) industries are more likely to be reorganized (liquidated) under U.S. bankruptcy code.