Two Essays on Corporate Reorganization under Chapter 11

This dissertation studies Chapter 11 reorganization from two different angles. It consists of two essays. The first essay investigates how different parties bargain during reorganization to settle the claims against the debtor. Specifically, I study bankrupt firms' performance during reorganization to investigate whether management engages in moral hazard activities to pressure creditors to forgive more debt. I find that bankrupt firms perform worse during reorganization than non-bankrupt firms with similar characteristics. I also find that increased alignment of interests between shareholders and management contributes to longer reorganization periods, higher reorganization expenses, and worse firm performance during reorganization. These findings suggest moral hazard problems during reorganization.

The second essay examines the efficacy of Chapter 11 reorganization. In this essay, I investigate two interrelated issues by studying post-emergence performance of bankrupt firms. The first issue concerns the choice between reorganization and liquidation. Specifically, I examine whether most firms that actually reorganize under Chapter 11 are the ones that should be reorganized as opposed to liquidated. I find that the performance of bankrupt firms is significantly improved after reorganization. This result indicates that Chapter 11 is generally able to screen out firms that cannot be rehabilitated and therefore should be liquidated. The second issue concerns how bankrupt firms are restructured. I find that debt-equity exchange specified in reorganization plans contributes to the improvement of post-emergence performance of bankrupt firms, but absolute priority rule (APR) deviation of equity does not. This result suggests that debt-equity exchange tends to reflect the beneficial recontracting among different parties to rehabilitate bankrupt firms. The rehabilitation is consistent with the common interests of all parties. However, APR deviation may result from the conflicts of interests, which do not contribute to performance improvement.

The first essay largely concentrates on how conflicts of interests influence a debtor’s behavior during reorganization, whereas the second one focuses on how conflicts of interests, together with common interests, affect a debtor’s choice between reorganization and liquidation and how they influence the debtor’s performance after reorganization. Together, the two essays contribute to a more comprehensive understanding of Chapter 11 reorganization.