Gaining through Corporate Bankruptcy: Evidence from Competitors

By Kolay, Madhuparna | International Journal of Business, Fall 2018 | Go to article overview

Gaining through Corporate Bankruptcy: Evidence from Competitors


Kolay, Madhuparna, International Journal of Business


I. INTRODUCTION

In this study, we examine the effect of corporate bankruptcy on a rival firm's equity. Corporate bankruptcy has many effects on its various stakeholders such as its bondholders, stockholders, employees and its industry i.e. its competitors. In general, bankruptcy conveys negative news about the filing firm and therefore, adverse effects are expected on the various groups. An exception however may arise in the case of a bankrupt firm's competitor since the peer firm may benefit due to increased market share from the potential removal of the distressed firm. On the other hand, sources of cash flow in industry rivals are likely to be correlated and therefore, corporate bankruptcy may convey bad news about the filing firm's peers as well. Even without actually conveying new information about the industry, the anticipation of related bad news due to the bankruptcy may lead peer firms to suffer from contagion (Lang and Stulz, 1992).

An interesting question in this area is: when does a firm gain from a rival's bankruptcy and when does it lose? Lang and Stulz (1992), who examine the effect on the equity of the filing firms' rivals, posit that the competitive effects are likely to arise when firms operate in concentrated industries and a rival is relatively less levered and therefore, in a stronger financial position to take advantage of the market share increase. In contrast, firms operating in competitive industries do not have much scope for market share gains and are more likely to be affected negatively. Lang and Stulz find corroborating evidence in their study of 59 bankruptcies between 1970 and 1989. They found evidence of competitive effects for those rivals which had lower leverage and operated in concentrated industries, though these effects were smaller than observed contagion effects. However, subsequent research has not been able to provide direct evidence about the existence of such competitive effects. In a study similar to that of Lang and Stulz, but using an expanded sample, Ferris, Jayaraman, and Makhija (1993) were not able to find any significant competitive effects. They concluded that it was likely that news about the bankruptcy was already incorporated into market prices at the time of filing. Other studies find indirect evidence of competitive effects. Jorion and Zhang (2007) study jumps in the prices of CD swaps to investigate competitive and contagion effect in both Chapter 7 and Chapter 11 bankruptcies. They find that competitive effects are relatively more evident in their Chapter 7 sample. Intuitively, these firms are filing with the aim of liquidation, and not in order to restructure, and therefore, rivals' probability of gain is higher. Filing for Chapter 11 may weaken a firm and therefore, benefit the rivals. On the other hand, a filing firm may reemerge with lower leverage and less contractual obligations. Zhang (2010) examines this question and finds that when rivals emerge from the Chapter 11 process, firm experience significantly negative competitive effects (-6%) over 200 days following the emergence date.

Conceptually, a rival stands to gain the most market share only if the bankrupt rival is completely eliminated from the market. Therefore, from an intuitive standpoint, the ex-ante probability that a filing firm emerges successfully from the Chapter 11 process and remains a rival in the long run ought to play a major role in determining the wealth effects on rivals at the time of filing. In this study, we examine this issue in a sample of 219 Chapter 11 filings which took place between 1980 and 2009 by accounting for various factors which directly affect the probability of successful reorganization of a filing firm. We start by using Lemmon, Ma, and Tashjian's (2009) classification scheme for Chapter 11 filings by distress type: financial versus economically distressed. Lemmon et al. (2009) show that one of the main determinants of the outcome of the Chapter 11 process is the type of distress faced by the filing firm. …

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