The Impact of Chapter 11 Filings on the Risk and Return of Securityholders, 1979-1989

Abstract

This paper re-examines the reaction of stockholders and bondholders to announcements of filing of Chapter 11 with a sample of 274 NYSE/AMEX and NASDAQ firms that announce bankruptcy during the period 1979-1989. Although the market reaction of these securityholders is the subject of considerable recent research, the literature contains only limited empirical evidence on bankruptcies in the period following the enactment of the 1978 Bankruptcy Reform Act (BRA). We find that both sets of securityholders experience significant losses in the days immediately surrounding the announcements, as would be expected if investors recognize that attempts to avoid bankruptcy costs through cheaper workouts have apparently failed. However, these losses are smaller than those associated with bankruptcies occurring prior to the BRA. One interpretation of these findings is that bankruptcy costs are lower under the 1978 law. Furthermore, our larger sample permits us to compare stock price reactions to bankruptcy announcements by NYSE/AMEX firms with those by NASDAQ firms; NASDAQ firms experience significantly larger losses (the difference is -10.29% with a z-statistic of 17.46), consistent with the notion that smaller firms have relatively larger bankruptcy costs. Also, our analysis of recent bankruptcies reveals the same puzzle that earlier researchers report; despite the sharp rise in leverage and significant increases in variance of returns (and residual risk), betas decline significantly as the announcement of the filing approaches. Finally, we report that lower rated bonds suffer larger losses, since their claims are more likely to be affected before those of senior bondholders.

JEL Classification: G33