Hedge Funds in Chapter 11

Abstract

This paper examines the roles of hedge funds in the Chapter 11 process and their effects on bankruptcy outcomes, using a comprehensive sample of 474 Chapter 11 filings from 1996 to 2007. We first show that hedge funds’ strategic choices in the timing of their presence and their entry point in the capital structure allow them to have a big impact on reorganization. Their presence as creditors is associated with a higher probability of emergence, and their presence as shareholders is associated with more deviations from the absolute priority rule. Further, hedge fund involvement is positively associated with more frequent adoptions of key employee retention plans and increased CEO turnover. Our research suggests that hedge funds are an emerging force underlying the changing nature of Chapter 11.