Bankruptcy Resolution : Misery or Strategy

Contrary to the conventional wisdom, this study reports the presence of a positive relation between large United States firms’ leverage levels and their likelihood of emerging from Chapter 11 bankruptcy. In anticipation of favourable court outcome, which allows them to emerge from bankruptcy with reduced debt, firms tend to increase their leverage levels in the years preceding the bankruptcy filing year. Thus, suggesting strategic abuse of bankruptcy courts and creditors. Test results suggest that firms start acting strategically up to four years before filing for bankruptcy, so that they can emerge with a reduced debt burden at the cost of creditors. Additionally, our study contributes to the corporate bankruptcy literature by exploring a set of factors (related to firm, judicial, case, geographic, and macroeconomic characteristics) explaining the likelihood of firms emerging from bankruptcy. Based upon the empirical analysis, we propose a comprehensive ten-factor multivariate Probit model that best predicts the likelihood of firms emerging from Chapter 11 bankruptcy