Business-Bankruptcy After the BAPCPA: Evidence From the Stock Market

Abstract

Little is known about how the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) affects the business-bankruptcy landscape in the United States. This study addresses this gap in the literature by investigating the stock price dynamics of firms filing for Chapter 11 under both the 1978 Bankruptcy Act and the BAPCPA. Results show that, on average, shareholders of firms filing for Chapter 11 under the new Act lose significantly more both at and shortly after the event date than their 1978 counterparts do. Given the economic magnitude and robustness of these findings, this article’s empirical evidence suggests the market perceives the BAPCPA to be more creditor-friendly than its predecessor is.

Keywords

BAPCPA Chapter 11 bankruptcy financial distress abnormal returns

Introduction

The Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), signed into law on April 20, 2005 by President George W. Bush, is the latest and one of the broadest reforms of the U.S. Bankruptcy Code. The new Act introduced numerous consumer-related changes, which have merited a broad debate in the literature (e.g., Lupica, 2011; McPherson, Friesner, Hackney, & Barnes, 2012; Ondersma, 2009). Yet, to date, there is still limited evidence on the impacts of the BAPCPA in the business-bankruptcy landscape (Teloni, 2014).

Currently, two opposing schools of thought coexist. On one hand, deterrents of the new Code claim it is the biggest victory of creditors and other special interest groups (e.g., Borukhovich, 2010; Levin & Raney-Marinelli, 2005; Miller, 2007). Those siding with this view argue that the BAPCPA created a “creditor-in-possession” Chapter 11 model, which limits debtors’ control over the reorganization proceedings, and systematically depletes them of both cash and time (e.g., Altman & Hotchkiss, 2005, pp. 47-55; Ayotte & Morrison, 2009; Gilson, 2010, pp. 82-83). On the other hand, supporters of the new Act sustain that it simply rationalizes the Chapter 11 process without materially affecting the dynamics of business bankruptcy. Their inspiration is rooted in one of the central tenets in economics: in the long-run, goods must be produced at marginal cost (Jehle & Reny, 2001, pp. 153-158). It follows that bankruptcy codes aiming at maximizing the overall economic efficiency must ensure that inefficient firms are systematically driven out of the market (White, 1989). Under such setup, the BAPCPA’s allegedly creditor-friendly business-related provisions may, in fact, be quite appealing if they merely speed up the dissolution of economically failed companies that would liquidate regardless (Nathan, Cargill, Banker, Udem, & Sandler, 2010).

The present study contributes to this debate by investigating the stock price dynamics of firms filing for bankruptcy in the pre- and post-BAPCPA period. This article finds that the long-term and short-term pre-Chapter 11 stock price abnormal performance is similar whether the case is filed under the BAPCPA or the 1978 Bankruptcy Code. Yet, in a novel contribution to the literature, this article shows that BAPCPA cases lose, on average, 49.1% of their value in market-adjusted terms around their bankruptcy announcement date, whereas the equivalent figure for the 1978 Code cases is only −28.7%. Such large difference in performance is statistically significant and seems economically important. In particular, on average, over the 3-day window centered on the Chapter 11 announcement date, each firm filing under the BAPCPA loses US$30 million, whereas its pre-BAPCPA counterpart experiences a comparable loss of only US$4.5 million. Put differently, filing for Chapter 11 after the passing of the 2005 Bankruptcy Code increases the nominal loss in shareholder wealth by a factor of more than six and half. Looking into the stock price dynamics of the sample firms over the first post-Chapter 11 week is also very revealing. In effect, over such a period, there is evidence that equity holders of firms in the sample filing under the new Code sustain an (additional) loss of 7.7% in risk-adjusted terms, whereas their 1978 Act peers enjoy an average positive stock abnormal return of 10.1%. Such asymmetric performance again seems important from an economic perspective. On average, over the 1-week postevent window, shareholders of companies in the post-BAPCPA set suffer an (additional) nominal loss in value that is four times bigger than that endured by the equity holders of firms in the sample filing for Chapter 11 under the old 1978 Bankruptcy Code.

This study is important for two main reasons. First, it helps to shed light on the business-related effects of the BAPCPA, a clearly underresearched topic in the literature. To the best of the author’s knowledge, Teloni (2014) is the only parallel study but focus on whether the new Code affects the reorganization rates and the mechanisms employed to settle Chapter 11. In contrast, the present study investigates how the U.S. equity market prices the effects of the passing of the BAPCPA as expressed by the stock price abnormal performance of firms entering bankruptcy proceedings. There is evidence that new Code is more taxing on shareholders, which suggests the market perceives the BAPCPA as being more creditor-friendly than its predecessor.

Second, examining the stock price dynamics of Chapter 11 firms both before and after October 12, 2005 is a contribution to the literature in its own right as the previous research focuses exclusively in pre-BAPCPA periods (e.g., Aharony, Jones, & Swary, 1980; Clark & Weinstein, 1983; Coelho, 2015; Coelho, Taffler, John, & Kumar, 2014; Datta & Iskandar-Datta, 1995; Dawkins, Bhattacharya, & Bamber, 2007; Morse & Shaw, 1988). This article’s main conclusion is that bankruptcies filed under the new Code lead to more negative postfiling, and announcement period stock abnormal returns than similar events occurring under the old 1978 Act. This study also adds to the previous bankruptcy literature by showing that, once the BAPCPA is enacted, following Chapter 11 announcements, the market continues to significantly penalize failed firms’ stock price. Such result is at odds with the previous findings of Dawkins et al. (2007) and Schatzberg and Reiber (1992), who focus on the pre-BAPCPA period, and emphasizes the importance of the legal setting when investigating the stock price dynamics of distressed companies.

The article proceeds as follows. The next section reviews the literature concerning the market’s reaction to the announcement of bankruptcy, briefly discusses some amendments enacted by the BAPCPA, and presents the main research question explored in this study. This article then summarizes the data and presents the results. The final section concludes.

Literature Review

Market Reaction to Bankruptcy Announcements

According to the American Bankruptcy Institute, more than 600,000 businesses filed for bankruptcy in the United States between 2000 and 2015.¹ Most of these businesses are small firms that are locally operated (Altman, 1999, p. 3). Yet, major corporations also seek protection from creditors with the help of bankruptcy law. For instance, in 2015, firms such as Caesars Entertainment Operating Company, Inc.; Alpha Natural Resources, Inc.; Doral Financial Corporation; Samson Resources Corporation; or Walter Energy, Inc. entered into bankruptcy proceedings, carrying more than US$42 billion in assets on their balance sheets at the filing date.²

An extensive academic literature addresses a wide range of bankruptcy-related issues,³ and, not surprisingly, the effects of filing for Chapter 11 on distressed companies’ stock are well explored. Altman (1969) is among the first to investigate this topic using 70 corporations that fail before the implementation of the Bankruptcy Reform Act of 1978. After controlling for risk factors, the author reports that the average performance of his bankrupt firms is similar to that of common stocks listed on the New York Stock Exchange (NYSE). A few years later, Aharony et al. (1980) analyze the risk–return characteristics of 45 industrial bankrupt companies filing for Federal protection under the Chandler’s Act and report a sharp decline in the stock price of such firms 7 weeks before the actual filing date. In the same vein, Clark and Weinstein (1983) use a sample of firms filing for Chapter X or XI between June 1938 and September 1979 and find that the shareholders of such companies sustain substantial losses at the bankruptcy announcement date. In 1992, Schatzberg and Reiber replicate the study of Clark and Weinstein (1983) using an independent data set and find that the postbankruptcy price movements are consistent with the hypothesis of overreaction and subsequent price rebound.

Rimbey, Anderson, and Born (1995) use a sample of 140 firms to study how the enactment of the 1978 Bankruptcy Reform Act affects shareholders’ wealth. They report that post-1978 Reform Act filings lead to more extreme negative prefiling and announcement period stock returns than their pre-1978 counterparts do. In a related study, Morse and Shaw (1988) show that buying-and-holding the stock of bankrupt firms filing under the 1978 Bankruptcy Code yields positive but not statistically significant abnormal returns in the longer run. Rose-Green and Dawkins (2000) take a different approach and use a sample of 77 firms filing for Chapter 11 between 1980 and 1996 to explore whether, at the time of the bankruptcy filing, the market differentiates between firms that are subsequently liquidated or reorganized. They report that firms that end up liquidated exhibit significantly larger negative abnormal returns in the year leading up to their bankruptcy announcement date, and at the event date than firms that eventually reorganize under Chapter 11.

Dawkins et al. (2007) study a sample of 272 firms that file for Chapter 11 between 1993 and 2003 and find evidence consistent with the market overreacting to the announcement of bankruptcy in the short term. More recently, Coelho (2015) investigates the medium-term in-bankruptcy stock performance of 275 U.S. industrial firms that file for Chapter 11 between 1979 and 2005 and finds a significant postbankruptcy announcement drift of at least −12.5% over the following 6 months.

BAPCPA and the U.S. Bankruptcy Law

One of the main advantages of Chapter 11 is that it grants debtors the ability to remain in control of the bankruptcy case. This is due to the “exclusivity” right regulated by section 1121 in the old 1978 Bankruptcy Code, which established that debtors were the only party in interest permitted to file a plan of reorganization within 120 days after the commencement of the case. Yet, Bankruptcy Judges would usually grant multiple extensions and, as a result, debtors often enjoyed an exclusivity right that lasted for several years (e.g., Altman & Hotchkiss, 2005, pp. 38-39). BAPCPA left section 1121 largely unchanged but fine-tuned subsection (d)(2). In particular, it still stipulates that the debtor has the exclusive right to file a reorganization plan for 120 days after the filing of the case. However, subsections 1121(d)(2)(A),(B) now limit the possibility of courts to extend such right beyond 18 months, plus 2 months for confirmation. Thus, this small but very important change curtails the bargaining power of debtors at the reorganization table by substantially reducing their control over the length of the proceedings, a key aspect of the Chapter 11 process.

The way the BAPCPA deals with the leases of commercial property is yet another example of how it limits bankrupt firms’ ability to stay in control of the reorganization process. Under subsection 365(d)(4) of the 1978 Bankruptcy Code, debtors were granted a 60-day period to decide on whether or not to assume a lease, but, in practice, Courts repeatedly extended such deadline. As a result, debtors enjoyed a very valuable advantage, that is, deferring the lease assumption/rejection decision until late in the bankruptcy proceedings. BAPCPA’s subsection 365(d)(4) actually extends the assumption/rejection period to 120 days, providing for an initial 90-day extension. Yet, any other extension requires the written consent of the lessor. Such change significantly enhances the landlords’ position, eventually leading bankrupt firms to decide ineffectively which leases to assume or reject.

The amendments made to subsection 362(c) are another subtle example of how the BAPCPA limits debtors’ control over the bankruptcy proceedings. Prior to 2005, firms could repeatedly seek relief under Federal bankruptcy law without enduring any particular penalization. Now, subsection 362(C) of the BAPCPA stipulates that, unless the court grants an extension, the automatic stay is lifted in 30 days after the commencement of case if the firm filed for Chapter 11 or Chapter 7 less than 1 year after reorganizing in Chapter 11. Similarly, the modification to section 1112 introduced by the BAPCPA also reduces debtors’ latitude while in bankruptcy. Under the 1978 Bankruptcy Code, the same section provided that if certain criteria were met, the bankruptcy court had discretionary authority to convert or dismiss a Chapter 11 case. The BAPCPA now stipulates that Courts shall move to convert or dismiss the Chapter 11 case on request of a party in interest after a notice, and a hearing unless “the court finds and specifically identifies unusual circumstances establishing that converting or dismissing the case is not in the best interests of the creditor and the estate.” This change significantly limits the discretion of the Court, which clearly favors creditors, who can now exert significant pressure on the debtor by threatening to make a motion to convert or dismiss the Chapter 11 case.

The new Act is also much more stringent in terms of liquidity requirements than the 1978 Bankruptcy Code. Subsection 1129(a)(9)(A) is a good example of this situation, establishing an “administrative solvency” test according to which a reorganization plan can only be confirmed if the debtor can pay all administrative expenses in full and in cash by its effective date. Pre-2005, the term “administrative expenses” was limited to operational expenses incurred post petition (Schlerf, 2007) plus expenses associated with the reorganization procedure itself. Yet, the BAPCPA significantly changed this. For instance, its subsection 503(b)(9) creates an administrative claim for goods received by the debtor within 20 days prior to the petition date. As a result, vendors may now demand immediate payment of their prepetition claims even before the confirmation of the plan, with debtors having to satisfy such claims in full. Under the 1978 Bankruptcy Code, these were unsecured claims, subject to plan voting and thus compromisable without the creditor’s consent. This change clearly harms the chances for a successful reorganization (Levin & Raney-Marinelli, 2005; Wilson & Long, 2011) and may also discourage Debtor-in-Possession financing, which is usually important in a traditional reorganization effort (Gottlieb, 2008).

The modifications introduced by the BAPCPA also affect the liquidity of debtors by substantially altering their relationship with utility firms. Subsection 366(A) of the 1978 Bankruptcy Code established that utilities were required to provide services to firms in Chapter 11 as long as they could provide “adequate assurance” of future payment. The assurances offered would usually be nonmonetary, such as administrative priority and existence of prepetition deposits. In addition, debtors relied on their payment history of utility services to establish “adequate assurance” of future payment. The enactment of the BAPCPA, however, completely altered the status quo. In particular, subsection 366(C) expressly defines what constitutes an “assurance payment,” which includes cash deposits, letter of credit, a certificate of deposit, a surety bond, or prepayment of utility consumption. Thus, this change in the bankruptcy law eliminated all “cashless” forms of adequate assurance of postpetition utility payments (Fishman, 2005), tipping the balance in favor of utilities (Misken & Boehm, 2007). The effects of new subsection 366(C) on the failed firm’s liquidity are clear. In fact, the necessity to post a cash equivalent to assure payment further depletes debtors of much needed cash, which is particularly important when the failed firm must deal with multiple utility companies.

Summary and Research Question

Extant research unanimously shows that filing for Chapter 11 is a very powerful public signal that leads to significant negative abnormal stock returns before, at, and after the formal bankruptcy announcement date. As discussed above, the BAPCPA introduced several amendments that seem to have made the U.S. Bankruptcy Law much tougher on corporate debtors. In fact, the new Code strengthened many of the creditors’ rights while curbing the ailing firms’ ability to remain in control of the bankruptcy proceedings. Furthermore, it also significantly increased the liquidity requirements for a successful reorganization. To what extent did these legal changes affect how the market deals with the announcement of Chapter 11 bankruptcy? This is the main research question explored in the present study. Answering it helps shedding light on the business-related impacts of the BAPCPA, an underresearched area of the literature, and adds to the existing knowledge on the market’s reaction to bankruptcy announcements, which currently draws only on pre-BAPCPA research.

Data and Descriptive Statistics

Table 1 shows that the sample for this study is compiled from a list of Chapter 11 cases collected from the bankruptcydata.com portal and the bankruptcy research database (BRD). Cases with no data available on the Center for Research in Security Prices (CRSP) database or COMPUSTAT are deleted. Next, firms that do not trade common stock on the Nasdaq, Amex, or the NYSE after their Chapter 11 filing date are removed. In the final step, utilities and financials are deleted as the bankruptcy law applies differently to the former, and the latter are heavily regulated. The final sample encompasses 323 bankruptcies, most of which (243 or 75.2% of the total cases) are filed under the 1978 Bankruptcy Act (i.e., prior to October 12, 2005). This is the pre-BAPCPA set. Another 80 bankruptcies (or 24.8% of the total cases) are governed by the BAPCPA and comprise the post-BAPCPA set.

Table 1.

Defining the Sample.

	Frequency
Chapter 11 cases listed on BDATA and BRD	2,280
Cases not found or with insufficient data on CRSP or COMPUSTAT	1,242
Cases not trading common stock on a major U.S. exchange post event	699
Utilities and financials	16
Final sample	323
Cases initiated under the 1978 Bankruptcy Act	243
Cases initiated under the BAPCPA	80

Note. An initial list of firms filing for Chapter 11 in the United States between January 01, 1988 and December 31, 2015 is compiled using data from the BDATA and the BRD. All bankruptcies with no data on CRSP or COMPUSTAT are deleted, as well as cases that do not trade common stock on the NYSE, Amex, or Nasdaq after the Chapter 11 filing date. Financial and utility firms are also removed from the final sample. Cases initiated under the 1978 Bankruptcy Act are bankruptcies in the sample that are filed between January 01, 1988 and October 12, 2005. Cases initiated under the BAPCPA are bankruptcies in the sample filed after October 12, 2005. BDATA = bankruptcydata.com portal; BRD = bankruptcy research database; CRSP = Center for Research in Security Prices; BAPCPA = Bankruptcy Abuse Prevention and Consumer Protection Act.

In general, the bankruptcies in the sample are evenly spread across the different years. There is, however, some concentration of cases in 1990 and 1991 (2009) in the pre-BAPCPA (post-BAPCPA) period. The sample firms typically trade on the Nasdaq post event. In particular, 69.5% of the cases initiated under the 1978 Bankruptcy Act trade on such exchange; the parallel figure for the post-BAPCPA set is 88.8%. The majority of the bankruptcies in the sample compete in the consumer goods industry in the pre-BAPCPA period (42.3% of the total cases in such period). After the passing of the BAPCPA, the sample is concentrated on the hi-tech (30.0% of the post-BAPCPA cases) and manufacturing sectors (26.3% of the post-BAPCPA cases).

Table 2 presents summary statistics of the sample firms. As can be seen, they are of similar size and display a comparable indebtedness level irrespective of filing for Chapter 11 before or after the enactment of the BAPCPA. In particular, for the pre-BAPCPA set, the mean market value is US$24.7 million, mean sales are US$1,051.6 million, and the mean leverage ratio is 50.4%. Comparable figures for the post-BAPCPA set are US$51.8 million, US$946.9 million, and 61.7%, respectively. None of the t or Wilcoxon–Mann–Whitney tests for these three variables is significant. Table 2 also shows that the typical firm in the sample is losing money: the mean return on assets for the pre-BAPCPA set is −16.0%; its post-BAPCPA counterpart is −27.8%. The t and Wilcoxon–Mann–Whitney tests are now significant, suggesting that firms filing for Chapter 11 under the new Code are relatively worse off economically than their pre-BAPCPA equivalents.

Table 2.

Summary Statistics.

Variable	Pre-BAPCPA		Post-BAPCPA		Diff. (Pre–post)
	M	Median	M	Median	M	Median
SIZE (US$ million)	24.7	8.5	51.8	10.5	−27.1	−2.0
SALES (US$ million)	1,051.6	145.6	946.9	258.1	104.7	−112.5
LEV	50.4%	42.8%	61.7%	46.0%	−11.3%	−3.2%
ROA	−16.0%	−5.4%	−27.8%	−13.5%	11.8%***	8.1%**
MOM	−40.6%	−57.1%	−31.8%	−60.7%	−8.8%	3.6%
TURN	0.02%	0.01%	0.03%	0.02%	−0.01%***	−0.01%***
QUOTED	13.8%	10.4%	4.2%	2.4%	9.6%***	8.0%***

Note. SIZE: market capitalization, in US$ million, one day before the Chapter 11 filing date. SALES: sales, in US$ million. LEV: leverage proxy (total debt/total assets). ROA: return on assets (net income/total assets). MOM: Jegadeesh and Titman’s (1993) momentum, computed over the 6-month period preceding the bankruptcy announcement month. TURN: average daily turnover (volume/shares outstanding) computed over the 1-month period preceding the bankruptcy announcement date. QUOTED: quoted bid-ask spread for the 1-month period preceding the bankruptcy announcement month, computed as in Stoll and Whaley (1983). All accounting data are from the last annual accounts reported before the bankruptcy filing year. The last two columns show the significance level of a t test and a Wilcoxon–Mann–Whitney test for difference in means and medians, respectively. BAPCPA = Bankruptcy Abuse Prevention and Consumer Protection Act.

Significant at the 10% level. **Significant at the 5%. ***Significant at the 1%.

Table 2 also shows that firms in both sets sustain important losses in market value in the 6-month period preceding the bankruptcy announcement date (on average, around 40% in the case of the pre-BAPCPA cases, and 32% for the post-BAPCPA set). Interestingly, there is evidence that post-BAPCPA firms are more heavily traded in the period leading up to their Chapter 11 date, enjoying lower transaction costs vis-à-vis their pre-BAPCPA peers.

Market Reaction to the Announcement of Chapter 11 Bankruptcy: Initial Evidence

Following Clark and Weinstein (1983), Dawkins et al. (2007), and Morse and Shaw (1988), cumulative abnormal returns (CARs) are used to assess the stock price performance of the sample firms before, at, and after the formal Chapter 11 announcement date. For announcing firm j, the abnormal return in day t ( $A R_{j, t}$ ) is computed as

A R_{j, t} = r_{j, t} - E (r_{j, t}),

(1)

where $r_{j, t}$ is the rate of return for the common stock of announcing firm j on day t, and $E (r_{i, t})$ is the expected return for such firm, and trading day. Equation 1 is computed using daily returns collected from CRSP. Following Clark and Weinstein (1983) and Rose-Green and Dawkins (2000), the CRSP equally weighted returns are employed as a proxy for the expected returns when computing Equation 1. Next, CARs for each announcing firm j are computed using Equation 2:

CA R_{j, τ} = \sum_{τ = t_{1}}^{t_{2}} A R_{j, τ},

(2)

where $A R_{j, t}$ is defined as in Equation 1, and $τ$ is a given event period. Individual CARs are then averaged cross-sectionally as follows:

{\bar{CAR}}_{τ} = 1 / 1 n n \sum_{j = 1}^{n} CA R_{j, τ},

(3)

where $CA R_{j, τ}$ is defined as in Equation 2, and $n$ is the number firms for which return data are available for event period $τ$ . As suggested by Equation 3, this study employs equally weighted returns, which are deemed to be more appropriate than value-weighted returns when dealing with the stock of distressed firms (e.g., Gilson, 1995). Furthermore, event day $t = - 1$ is included in the bankruptcy announcement window together with days $t = 1$ , and $t = 0$ (the bankruptcy announcement date) as firms may file their bankruptcy petition after the market closes (Dawkins et al., 2007).

Bankruptcies typically lead to substantial changes in the affected firm’s business prospects, which influence the parameters of the firm’s stock return distribution (Aharony et al., 1980). As such, to be conservative and following prior research on the price reaction to bankruptcy filings (e.g., Dawkins et al., 2007; Morse & Shaw, 1988), this article computes t statistics based on cross-sectional variances to test the null hypothesis that the mean CAR is equal to zero. Furthermore, drawing on Kraft, Leone, and Wasley (2006), CARs are Winsorized at the 1% and 99% level.⁴ For robustness, median abnormal returns are also reported, along with the corresponding Wilcoxon signed rank-test results (Dawkins et al., 2007).

Some sample firms delist from the main exchanges after filing for Chapter 11. To reduce the impact of firm delisting in the results, this article only explores a 1-week postfiling period.⁵ Drawing on Shumway (1997) and Shumway and Warther (1999), firms’ delisting returns are included when computing their abnormal performance, and delisted firms are assumed to earn a zero abnormal return in the postdelisting period (Kausar, Taffler, & Tan, 2009).⁶ Finally, in order to answer this article’s main research question, CARs are computed separately for Chapter 11s filed before and after October 12, 2005. The stock price performance of these two sets of firms is compared over different event periods using both t and Mann–Whitney tests.

Table 3 summarizes the results of this analysis. Panel A shows what happens before the bankruptcy date. For the 1-year preevent window, the mean (median) CAR for the pre- and post-BAPCPA portfolios is −73.5% (–92.6%) and −94.6% (–95.1%), respectively. Parallel figures for the 6-month period are -55.7% (–64.1%) and −60.6% (–73.6%). Importantly, all t and Wilcoxon–Mann–Whitney tests for these event windows are not statistically significant, indicating that the long-term loss in shareholder value in the prepetition period is similar whether the bankruptcy proceedings are initiated under the 1978 Bankruptcy Code or the BAPCPA. In addition, Panel B of Table 3 shows that the market equally anticipates the announcement of Chapter 11 irrespective of the Code that governs the proceedings. In fact, both the t test and the Wilcoxon–Mann–Whitney test are not significant for the (–6, −2) event period.

Table 3.

Market Reaction to Chapter 11: Initial Evidence.

Compounding period	Pre-BAPCPA		Post-BAPCPA		Diff. (Pre–post)
	M	Median	M	Median	M	Median
Panel A: Pre-Chapter 11 abnormal stock returns
(–252, −2)	−73.5%	−92.6%	−94.6%	−95.1%	21.1%	2.5%
p value	<.01	<.01	<.01	<.01	.17	.22
(–126, −2)	−55.7%	−64.1%	−60.6%	−73.6%	4.9%	9.5%
p value	<.01	<.01	<.01	<.01	.71	.39
Panel B: Short-term market anticipation and reaction to Chapter 11 bankruptcy
(–6, −2)	−8.4%	−6.2%	−3.6%	−3.8%	−4.8%	−2.4%
p value	<.01	<.01	.06	.05	.28	.22
(–1, 1)	−28.7%	−29.1%	−49.1%	−56.4%	20.4%	27.3%
p value	<.01	<.01	<.01	<.01	<.01	<.01
(2, 6)	10.1%	2.6%	−7.7%	−17.9%	17.8%	20.5%
p value	<.01	.06	.03	<.01	.02	<.01
Panel C: Abnormal stock returns around Chapter 11 filings
(–6, 6)	−26.9%	−22.1%	−59.4%	−69.1%	32.5%	47.0%
p value	<.01	<.01	<.01	<.01	<.01	<.01

Note. Firms in the pre-BAPCPA (post-BAPCPA) set file for Chapter 11 before (after) October 12, 2005. Expected returns are the returns from the CRSP equally weighted portfolio, including dividends. p values, from t statistics based on cross-sectional variances (from a Wilcoxon signed rank-test) are reported below the mean (median). BAPCPA = Bankruptcy Abuse Prevention and Consumer Protection Act; CRSP = Center for Research in Security Prices.

Panel B of Table 3 also shows a very strong and negative market reaction to the announcement of Chapter 11, a result already documented by previous authors (e.g., Clark & Weinstein, 1983; Coelho, 2015; Coelho et al., 2014; Dawkins et al., 2007; Morse & Shaw, 1988; Rose-Green & Dawkins, 2000). Yet, in a novel contribution to the literature, this article finds that filing for Chapter 11 in the post-BAPCPA period is substantially more harmful to the interests of extant equity holders than doing so under the 1978 Bankruptcy Code. In effect, the mean (median) CAR for the set of firms filing under the old Code computed over the (–1, +1) window is −28.7%, significant at the 1% level (–29.1%, p < .01), whereas its counterpart value for the post-BAPCPA set is a hooping −49.1% (p < .01) (–56.4%; p < .01). Not surprisingly, the t and the Wilcoxon–Mann–Whitney tests are statistically significant at better than the 1% level. Importantly, such difference seems economically relevant. Just before filing for Chapter 11 (i.e., in event day −1), the combined nominal market value of the 243 firms in the pre-BAPCPA set is around US$6 billion; 1 day after such an event, this figure drops to US$4.9 billion. Hence, over the 3-day period centered on the Chapter 11 date, companies in this set accumulate a loss of US$1.1 billion. The sample firms filing under the BAPCPA are, however, considerably worse off as, over the same window, they sustain a comparable loss of US$2.4 billion.⁷ In other words, on a per firm basis, shareholders of firms filing after the enactment of the new Bankruptcy Code lose, on average, 6.6 times more than their pre-BAPCPA peers do (i.e., US$30 million vs. US$4.5 million, respectively).

Panel B of Table 3 also shows that, on average, the market’s short-term response to the announcement of Chapter 11 critically depends on whether the firm files for bankruptcy before or after October 12, 2005. In fact, when cases are initiated under the 1978 Code, the mean CAR computed over the (+2, +6) interval is +10.1% (p < .01) (median = +2.6%; p = .06). As such, the evidence in Panel B of Table 3 suggests that the initial plunge in price that occurs at the formal Chapter 11 announcement date reverses over the following week. In contrast, market prices continue to fall in risk-adjusted terms when the bankruptcy is filed after the passing of the BAPCPA: the mean CAR is now −7.7% (p = .03), and the respective median is −17.9% (p < .01). This interesting finding directly adds to the literature. Previous research by Dawkins et al. (2007), and Schatzberg and Reiber (1992) already show that, under certain circumstances, the market may overreact to Chapter 11 announcements. However, the evidence on Panel B of Table 3 suggests that, in the aftermath of the BAPCPA’s enactment, on average, the market price of failed firms actually continues to plummet in risk-adjusted terms post event, something that may well be the result of the legal changes brought forward by the new Bankruptcy Code. It is also important to stress that the asymmetric market response to Chapter 11 filings documented above seems economically significant. In fact, on average, over the 1-week window following the announcement date, companies in the pre-BAPCPA set lose around US$0.6 million, yet their post-BAPCPA peers bear an analogous loss of US$2.5 million. This means that, over such a period, the equity holders of the sample firms filing for Chapter 11 after October 12, 2005 undergo a (additional) nominal loss in wealth that is 4.2 times bigger than that sustained by their 1978 Bankruptcy Code counterparts.

Panel C of Table 3 summarizes what happens in the 2-week period centered on the Chapter 11 date. As can be seen, the mean (median) CAR computed for the firms in the pre-BAPCPA set is −26.9% (p < .01) (–22.1%; p < .01), whereas its post-BAPCPA equivalent is significantly more negative: −59.4% (p < .01) (–69.1%; p < .01). This evidence helps to shed light on this article’s main research question. In effect, it clearly shows that shareholders stand to lose considerably more wealth in risk-adjusted terms around the Chapter 11 announcement date when their companies seek protection from creditors under the BAPCPA than when doing so under the old 1978 Code.

Additional Tests

Caution is needed in interpreting the findings above due to the special nature of the sample firms and the problematic nature of measuring abnormal returns (e.g., Barber & Lyon, 1997; Brown & Warner, 1980, 1985; Kothari & Warner, 1997, 2007; Lyon, Barber, & Tsai, 1999).

Thus, this article next controls for the impact of the 2008/2009 financial crises in the results and explores to what extent earnings surprise and momentum, that is, the two most well-established anomalies in the literature (Fama, 1998), affect the initial conclusions.

The 2008/2009 Financial Crises⁸

On September 15, 2008, Lehman Brothers filed that which is still the largest Chapter 11 case in the history of the United States. This single but catastrophic event deeply affected the credit market, a phenomenon that lasted up until the end of 2009. Many firms were forced into bankruptcy during this period, and reorganizing under Chapter 11 became understandably harder. However, the work of Brown and Cliff (2005), Baker and Wurgler (2006), Kaplanski and Levy (2010), and Mian and Sankaraguruswamy (2012), among others suggest a relation between market sentiment and bias on equity prices, something also documented by the bankruptcy-related literature. In fact, Dawkins et al. (2007) shows that overreaction to Chapter 11 filings seems to occur only during bull markets, which are periods characterized by optimistic investor sentiment. As a result, it is reasonable to suspect that the 2008/2009 financial crises may have had an impact on how the market deals with the announcement of bankruptcy, which would be an important confounding effect. This article explores to what extant this is a relevant issue by repeating the event study presented above while excluding the 24 firms in the sample that file for Chapter 11 between September 01, 2008 and December 31, 2009.

Table 4 summarizes the results of this important robustness test. In line with the initial evidence, Panel A shows that the longer term mean and median stock abnormal returns for both the pre- and post-BAPCPA sets are negative and statistically significant at normal levels. Once again, none of the t tests or Wilcoxon–Mann–Whitney tests are significant. The same pattern applies when one considers the 1-week period leading up to the Chapter 11 date. All stock abnormal returns computed for the (–6, −2) window in Panel B of Table 4 are negative and significant at normal levels; yet, both the parametric and the nonparametric test for differences in performance between the two groups yields a p value above the 10% level.

Table 4.

Market Reaction to Chapter 11—The Impact of the 2008/2009 Financial Crises.

Compounding period	Pre-BAPCPA		Post-BAPCPA		Difference (Pre–post)
	M	Median	M	Median	M	Median
Panel A: Pre-Chapter 11 abnormal stock returns
(−252, − 2)	−73.5%	−92.6%	−98.3%	−95.3%	24.8%	2.7%
p value	<.01	<.01	<.01	<.01	.15	.42
(−126, − 2)	−55.7%	−64.1%	−82.1%	−93.5%	26.4%	29.4%
p value	<.01	<.01	<.01	<.01	.31	.12
Panel B: Short-term market anticipation and reaction to Chapter 11 bankruptcy
(−6, − 2)	−8.4%	−6.2%	−4.1%	−3.6%	−4.3%	−2.6%
p value	<.01	<.01	.03	.01	.35	.23
(−1, 1)	−28.7%	−29.1%	−46.8%	−55.3%	18.1%	26.2%
p value	<.01	<.01	<.01	<.01	<.01	<.01
(2, 6)	10.1%	2.6%	−9.6%	−14.4%	19.7%	17.0%
p value	<.01	.06	.01	<.01	0.01	<.01
Panel C: Abnormal stock returns around Chapter 11 filings
(−6, 6)	−26.9%	−22.1%	−60.5%	−69.2%	33.6%	47.1%
p value	<.01	<.01	<.01	<.01	<.01	<.01

Note. Firms in the post-BAPCPA (pre-BAPCPA) set file for Chapter 11 after (before) October 12, 2005. Yet, the 24 companies filing for Chapter 11 between September 01, 2008 and December 31, 2009 are deleted from the sample. Expected returns are the returns from the CRSP equally weighted portfolio, including dividends. p values, from t statistics based on cross-sectional variances (from a Wilcoxon signed rank-test) are reported below the mean (median). BAPCPA = Bankruptcy Abuse Prevention and Consumer Protection Act; CRSP = Center for Research in Security Prices.

Panel B of Table 4 again shows a very negative, and significant market reaction to the announcement of bankruptcy. Importantly, even after excluding all the cases initiated between September of 2008 and December of 2009, the post-BAPCPA firms still exhibit a mean (median) negative stock abnormal return of −46.8% (p < .01) (−55.3%; p < .01) over the (−1, +1) event window. Noticeably, these figures are of similar magnitude to those reported in Table 3: in effect, the mean abnormal return for the post-BAPCPA set is −49.1% (p < .01) (median = −56.4%, p < .01). Furthermore, as in Table 3, the t and the Wilcoxon–Mann–Whitney test for the (−1, +1) event window are significant, suggesting that the market’s reaction to the announcement of Chapter 11 is much stronger once the BAPCPA is enacted even when the firms filing for bankruptcy during the financial crises are excluded from the analysis.

Exploring the 1-week period that follows the Chapter 11 date leads to similar conclusions to those reported above. The (+2, +6) event window mean and median stock abnormal returns for the post-BAPCPA set are again negative and statistically significant at normal levels. Moreover, both the t and the Wilcoxon–Mann–Whitney test computed for this period are significant, suggesting that the short-term market reaction to the announcement of Chapter 11 is different depending on whether the case is initiated under the 1978 Bankruptcy Act or the BAPCPA. In light of this evidence, one can conclude that this article’s initial results do not seem to be driven by a 2008/2009 financial crises effect.

Earnings Surprise

Previous research shows that earnings surprises are followed by an incomplete market reaction, which is more acute when the surprise is negative (e.g., Bernard & Thomas, 1989, 1990; Foster, Olsen, & Shevlin, 1984). To explore whether such effect confounds this article’s initial results, each of the sample firms is matched to a single firm based on industry affiliation, size, and earnings surprise.⁹ Barber and Lyon (1997) point out that the single control firm approach eliminates the new listing bias, the rebalancing bias, and the skewness problem, yielding well-specified test statistics. Ang and Zhang (2004) further argue that the single control firm method overcomes the issue of the event firm not being near the centroid of the respective matched portfolio in the reference portfolio approach, a problem that is more important with small firms, which this article’s population of bankrupt firms comprises.

The actual matching is as follows. First, an initial pool of match candidates is defined based on industry affiliation as Akhigbe, Martin, and Whyte (2005) and Lang and Stulz (1992) show that filing for Chapter 11 leads to an important intraindustry effect. In particular, for each bankrupt firm, a valid candidate is that with the same 2-digit SIC Code 1 year before the Chapter 11 announcement year. Potential matching firms that file for Chapter 11 in the same year as the sample firm are deleted. Next, firms with a market capitalization between 70% and 130% of that of the sample firm’s market capitalization are identified. This is because abnormal returns differ for small and large firms (e.g., Banz, 1981; Fama & French, 1992), with smaller firms being more likely to experience an incomplete market reaction to bad news (e.g., Chan, 2003; Dichev & Piotroski, 2001). In the next step, and drawing on Foster et al. (1984), the value of earnings surprise is computed for each sample firm and match candidates as follows:

Δ E S_{j, q} = \frac{E_{j, q} - E (E_{j, q})}{| E_{j, q} |},

(4)

where $Δ E S_{j, q}$ is the earnings surprise figure for firm $j$ in quarter $q$ , $E_{j, q}$ is the current quarterly earnings for firm $j$ , and $E (E_{j, q})$ is the expected earnings for firm $j$ in the current quarter. The current quarter is the most recent quarter preceding the bankruptcy announcement date, and to estimate Equation 4, the expected earnings figure is assumed to be the realized quarterly earnings for the same quarter in the previous year. The final control firm is the firm with the closest earnings surprise figure to that of the sample firm. In the end, the matching method leads the control and bankrupt firms to have essentially the same earnings surprise (in terms of sign and magnitude), while ensuring that the benchmark firms do not file for bankruptcy during the test period.

Table 5 summarizes the results of this test. As can be seen in Panel A, for the 1-year and 6-month preevent periods, all mean and median CARs are negative and significant at the 1% level. Yet, none of the t and Wilcoxon–Mann–Whitney tests are significant. A similar pattern holds for the short-term anticipation of the announcement of Chapter 11 depicted by the (−6, − 2) event window in Panel B.

Table 5.

Controlling for Industry, Size, and Earnings Surprise.

Compounding period	Pre-BAPCPA		Post-BAPCPA		Difference (Pre–post)
	M	Median	M	Median	M	Median
Panel A: Pre-Chapter 11 abnormal stock returns
(−252, − 2)	−94.7%	−98.3%	−92.4%	−97.9%	−2.3%	−0.4%
p value	<.01	<.01	<.01	<.01	.90	.76
(−126, − 2)	−66.1%	−62.8%	−59.3%	−74.5%	−6.8%	11.7%
p value	<.01	<.01	<.01	<.01	.54	.73
Panel B: Short-term market anticipation and reaction to Chapter 11 bankruptcy
(−6, − 2)	−11.2%	−9.2%	−1.7%	−1.2%	−9.5%	−8.0%
p value	<.01	<.01	.06	.07	.22	.15
(−1, 1)	−31.7%	−35.6%	−49.4%	−54.4%	17.7%	18.8%
p value	<.01	<.01	<.01	<.01	<.01	<.01
(2, 6)	9.6%	0.9%	−2.2%	−10.3%	11.8%	11.2%
p value	.01	.76	.05	.01	.02	<.01
Panel C: Abnormal stock returns around Chapter 11 filings
(−6, 6)	−32.8%	−34.5%	−53.2%	−66.8%	20.4%	32.3%
p value	<.01	<.01	<.01	<.01	<.01	<.01

Note. Firms in the pre-BAPCPA (post-BAPCPA) set file for Chapter 11 before (after) October 12, 2005. Abnormal performance is computed using a benchmark sample matched on industry (2-digit SIC Code), size (market capitalization at the bankruptcy announcement date), and earnings surprise (computed as in Foster et al., 1984). p values, from t statistics based on cross-sectional variances (from a Wilcoxon signed rank–test) are reported below the mean (median). BAPCPA = Bankruptcy Abuse Prevention and Consumer Protection Act.

Importantly, in line with the main results reported above, there is evidence that the market perceives the announcement of Chapter 11 as being significantly more negative when the proceedings are initiated after the enactment of the BAPCPA. In particular, for the pre-BAPCPA set, the mean (median) (−1, +1) CAR is −31.7% (−35.6%), significant at better than the 1% (1%) level. The corresponding post-BAPCPA mean and median CARs are −49.4% (p < .01) and −54.4% (p < .01), respectively. The difference in abnormal performance of these two sets of firms is statistically significant at better than the 1% level. Furthermore, Panel B of Table 5 again shows that, in the subsequent days to the formal announcement of Chapter 11, stock prices continue to plunge in risk-adjusted terms when the case is governed by the BAPCPA, something that does not hold for cases initiated under the 1978 Bankruptcy Code. In effect, the mean CAR of the former firms is −2.2% (p = .05) (median = −10.3%; p = .01), whereas the corresponding figure for the latter is 9.6% (p = .01) (median = 0.9%; p = .76). Based on these results, it can be concluded that this article’s initial findings are robust to any potential earnings surprise effect.¹⁰

Momentum

Table 2 shows that the stock price of the sample firms falls steeply during the prebankruptcy period. As such, it may be that the initial findings of this article are merely a continuation of these negative returns as in Jegadeesh and Titman (1993). To test whether this is the case, each of the bankrupt firms is matched with a new control firm.¹¹ In particular, as above, this article starts by identifying valid matching candidates using the 2-digit SIC Code 1 year before the Chapter 11 announcement year and deleting firms that file for bankruptcy in the same year as the sample firm does. Next, only firms with a market capitalization between 70% and 130% of that of the sample firm’s market capitalization are kept in the pool of potential matching candidates. Finally, from this set, the firm with momentum closest to that of the sample firm is selected. Momentum is computed as in Jegadeesh and Titman (1993) over a 6-month prebankruptcy period, using returns collected from the CRSP monthly tape.

Table 6 shows that this article’s main conclusions are unaffected when this new control sample is used. Indeed, none of the preevent t and Wilcoxon–Mann–Whitney tests are significant at normal levels, suggesting that the market equally anticipates the impending Chapter 11 announcement irrespective of the particular bankruptcy Code that governs the proceedings. Furthermore, there is evidence to suggest that the market’s reaction to the filing of Chapter 11 is significantly more negative in the case of the post-BAPCPA set than its pre-BAPCPA counterpart is. The mean CAR computed over the (−1, +1) window for the former group of firms is −49.6% (p < .01) (median = −54.6%; p < .01) and for the latter is −30.7% (p < .01) (median = −30.1%; p < .01). The t test (Wilcoxon–Mann–Whitney test) for the difference in means is significant at better than the 1% (1%) level. In addition, using industry, size and momentum risk-adjusted returns leads to the conclusion that there is an asymmetrical market response to the announcement of Chapter 11 depending on the Bankruptcy Code that is enacted at the time of the filing. In particular, the mean CAR computed for the (+2, +6) event window for the pre-BAPCPA cases is positive and significant, whereas its post-BAPCPA counterpart is negative and significant. Importantly, both the t test and the Wilcoxon–Mann–Whitney test for the (+2, +6) event window are significant at normal levels. In face of this evidence, one can conclude that this article’s initial findings cannot be explained in terms of the continuation of prior returns.¹²

Table 6.

Controlling for Industry, Size, and Momentum.

Compounding period	Pre-BAPCPA		Post-BAPCPA		Difference (Pre–post)
	M	Median	M	Median	M	Median
Panel A: Pre-Chapter 11 abnormal stock returns
(−252, − 2)	−45.2%	−51.3%	−67.4%	−71.0%	22.2%	19.7%
p value	<.01	<.01	<.01	<.01	.37	.53
(−126, − 2)	−26.8%	−23.2%	−35.8%	−31.3%	9.0%	8.1%
p value	<.01	<.01	<.01	<.01	.91	.71
Panel B: Short-term market anticipation and reaction to Chapter 11 bankruptcy
(−6, − 2)	−7.8%	−5.5%	−4.1%	−2.1%	−3.7%	−3.4%
p value	<.01	<.01	.32	.50	.37	.26
(−1, 1)	−30.7%	−30.1%	−49.6%	−54.6%	18.9%	24.5%
p value	<.01	<.01	<.01	<.01	<.01	<.01
(2, 6)	10.1%	5.7%	−7.6%	−15.0%	17.7%	20.7%
p value	<.01	.04	.02	<.01	.02	<.01
Panel C: Abnormal stock returns around Chapter 11 filings
(−6, 6)	−28.6%	−25.1%	−61.3%	−73.1%	32.7%	48.0%
p value	<.01	<.01	<.01	<.01	<.01	<.01

Note. Firms in the pre-BAPCPA (post-BAPCPA) set file for Chapter 11 before (after) October 12, 2005. Abnormal performance is computed using a benchmark sample matched on industry (2-digit SIC code), size (market capitalization at the bankruptcy announcement date), and momentum (computed as in Jegadeesh & Titman (1993) over the 6-month period preceding the bankruptcy announcement month). p values, from t statistics based on cross-sectional variances (from a Wilcoxon signed rank–test) are reported below the mean (median). BAPCPA = Bankruptcy Abuse Prevention and Consumer Protection Act.

Market Reaction to the Announcement of Chapter 11 Bankruptcy: Regression Analysis

This article now turns to regression analysis to further investigate the impact of the enactment of the BAPCPA on the abnormal stock price performance of failed firms. The regression model employed is as follows:

CA R_{j, τ} = α_{0} + β_{1} BAPCP A_{j} + \sum_{l = 1}^{7} λ_{l} Z_{l, j} + ε_{j},

(5)

where $CA R_{j, τ}$ is the market-adjusted CAR of firm j computed over event window (−1, +1) or (+2, +6), $BAPCP A_{j}$ is a bankruptcy-related dummy variable, $Z_{l, j}$ represents seven control variables, and $ε_{j}$ is the error term. BAPCPA_j is the explanatory variable of interest in Equation 5. This dummy variable is set to one when the Chapter 11 case is initiated under the new Bankruptcy Code, and zero otherwise. Thus, if the changes introduced by the BAPCPA are indeed priced by the market, $β_{1}$ should be negative and statistically significant. In effect, this would constitute evidence that, ceteris paribus, after the passing of the BAPCPA shareholders sustain larger loses (in risk-adjusted terms) around and after the Chapter 11 announcement date than their pre-BAPCPA counterparts do.

The regression model includes seven additional control variables. The first is institutional ownership (OWNER), defined as the percentage of shares held by institutional investors in the quarter leading up to the bankruptcy announcement date.¹³ This is an important control variable as such sophisticated investors have access to a variety of news reports and analyses and are guided by professional money managers (e.g., Cohen, Gompers, & Vuolteenaho, 2002; Ke & Ramalingegowda, 2005; Lakonishok, Shleifer, & Vishny, 1992; Nofsinger & Sias, 1999). As such, institutional investors should be able to better grasp the intricacies of the bankruptcy law and thus be in a superior position to anticipate how filing for Chapter 11 affects shareholders’ value. Hence, ceteris paribus, the stock price of the sample firms should deviate less from its fundamental value as institutional ownership increases.

Market price (PRICE) is the second control variable, computed as the natural log of the firm’s price per share in the day that precedes its bankruptcy announcement date. This variable helps incorporate the impacts of limits to arbitrage into the analysis. As Barberis and Thaler (2005) highlight, shorting stocks is sometimes challenging, which explains why arbitrageurs may refrain from correcting market pricing anomalies. Many of the sample firms in this study trade at prices below US$5 a share in the week leading up to their Chapter 11 date, with D’Avolio (2002) reporting that, in general, such penny-like type of stocks are hard to short. This explains why this article expects to find larger abnormal stock returns at and shortly after the Chapter 11 announcement date for the sample firms trading at lower per share prices.

Firm size (ASSETS) is the third control variable, which is computed as the natural log of total assets, collected from the reported accounts in the year that precedes the bankruptcy announcement year. Such variable is included in the regression model for two reasons. First, as previously mentioned, abnormal returns differ for small and large firms. Second, the previous literature suggests that information about small firms is likely to spread more slowly across investors (e.g., Hong, Lim, & Stein, 2000). As such, smaller firms going into Chapter 11 should, on average, experience larger abnormal returns.

Prebankruptcy distress is likely to be an important factor when explaining the abnormal stock performance of firms filing for Chapter 11. As argued by Rose-Green and Dawkins (2000), the poorer the pre-Chapter 11 financial condition of the announcing firm, the greater the probability of bankruptcy, and the smaller the surprise associated with the actual event. As a result, the score of the Altman’s (1968) function (ZSCORE) is included as a covariate in the estimation of Equation 5. Such variable is computed for each sample firm using data from the fiscal year end of the year preceding the bankruptcy announcement date.

In most cases, bankruptcy does not come as a total surprise as, in general, a string of other important, but less dramatic events, precedes it (e.g., Beneish & Press, 1995). Firms battered by numerous negative news in the preevent period should experience smaller abnormal stock returns around their Chapter 11 date. As a result, drawing on Rose-Green and Dawkins (2000), this article employs market-adjusted CARs computed over the 3-month prebankruptcy period to proxy for the volume of value-relevant information (PDI) known in advance of the Chapter 11 announcement date.

As previously mentioned, the 2008/2009 financial crises is a potentially important confounding effect and, as such, must be accounted for in the analysis to avoid incurring in a problem of incorrectly omitted explanatory variables. To do so, this article employs the dummy variable FINCRISES, which is set to one when a sample firm files for Chapter 11 between September 01, 2008 and December 31, 2009. This variable should be significant in the regression if, indeed, a 2008/2009 financial crises effect exists.

As pointed out by Dawkins et al. (2007), some firms negotiate their reorganization plans before filing for Chapter 11 in an attempt to speed up the bankruptcy proceedings, with the previous literature suggesting that such “prepacked” bankruptcies have special characteristics. For instance, Chatterjee, Dhillon, and Ramirez (1996) show that they are of higher quality in the sense that companies filing prenegotiated Chapter 11s tend to have higher ratios of operating cash flow to sales. Furthermore, Tashjian, Lease, and McConnell (1996) find that prepacked bankruptcies yield higher average recovery rates to creditors than traditional Chapter 11s do. As such, this article controls for the nature of the Chapter 11 being filed by each sample firm by including the dummy variable PREPACK in the regression model above. Such variable is set to one when the sample firm files a prepacked Chapter 11, which is determined by using information available on the bankruptcydata.com portal; the BRD database; the SEC’s Electronic Data Gathering, Analysis, and Retrieval system (EDGAR); and several Internet searches.¹⁴

Table 7 presents descriptive statistics for the continuous explanatory variables mentioned above.^15,16 As can be seen, in line with this article’s initial evidence, Table 7 shows that firms filing for Chapter 11 under the BAPCPA and the 1978 Code share similar size (as measured by the book value of assets) and experience a similar loss in shareholder value (as measured by PDI) in anticipation of the event.

Table 7.

Descriptive Statistics for the Continuous Explanatory Variables in the Regression Model.

Variable	Pre-BAPCPA		Post-BAPCPA		Difference (Pre–post)
	M	Median	M	Median	M	Median
OWNER	19.0%	11.5%	29.4%	21.8%	−10.4%***	−10.3%***
PRICE (US$)	1.4	0.8	0.9	0.4	0.5**	0.4***
ASSETS (US$ million)	935.2	204.3	1,208.3	275.9	−273.1	−71.6
ZSCORE	1.4	1.3	0.9	0.6	0.5***	0.7***
PDI	−24.9%	−20.3%	−34.4%	−40.4%	9.5%	20.1%

Note. OWNER: percentage of shares held by institutional investors in the quarter leading up to the bankruptcy announcement date. PRICE: price per share in the day preceding the bankruptcy announcement date (in dollars). ASSETS: book value of total assets, in US$ million. ZSCORE: bankruptcy-risk proxy (Altman, 1968). PDI: predisclosure information proxy, measured as each firm’s market-adjusted CAR computed over the 3-month period preceding the bankruptcy announcement date. All accounting data are from the last annual accounts reported before the bankruptcy filing year. The last two columns show the significance level of a t test and a Wilcoxon–Mann–Whitney test for difference in means and medians, respectively. BAPCPA = Bankruptcy Abuse Prevention and Consumer Protection Act; CAR = cumulative abnormal return.

Significant at the 10% level. **Significant at the 5%. ***Significant at the 1%.

Table 7 also shows that the firms in the post-BAPCPA set exhibit higher levels of institutional ownership than their pre-BAPCPA counterparts do. In fact, the mean (median) for the former group is 29.4% (21.8%), with the corresponding figure for the latter set of firms equal to 19.0% (11.5%); both the t and Wilcoxon–Mann–Whitney tests are significant. Furthermore, Table 7 shows that both sets of firms face an imminent danger of failure as per the Altman (1968) model. The mean Z-score value for the pre-BAPCPA (post-BAPCPA) set is 1.4 (0.9), with Altman establishing a cut-off point of 1.81 to identify firms that clearly fall within the bankrupt category. Importantly, both the parametric and nonparametric tests for differences computed for this variable suggest that firms filing under the BAPCPA experience a higher bankruptcy risk than their 1978 equivalents do. Finally, the evidence on Table 7 suggests that the sample firms trade at a very low price per share in anticipation to their formal Chapter 11 announcement date. This is especially true when the case is initiated under the BAPCPA. Firms filing under this Code have a mean (median) price per share of US$0.9 (US$0.4), whereas the counterpart value for firms filing under the 1978 Code is US$1.4 (US$0.8). The t and Wilcoxon–Mann–Whitney tests for this variable are significant at normal levels.

Table 8 summarizes the results of estimating Equation 5. CARs computed over the (−1, +1) [(+2, +6)] window are used as the dependent variable in Model I [II]. A Reset test is used to identify potential problems of incorrectly omitted variables, and/or incorrect functional form, together with a White test to account for heteroskedasticity.¹⁷ For Model I, the Reset test is not significant, but the White test is at the 5% level, which leads us to employ ordinary least squares (OLS) and standard errors corrected as suggested by White (1980). Model II does not seem to have problems of incorrect specification/functional form or heteroskedasticity and thus is estimated using OLS.

Table 8.

Market Reaction to Chapter 11—Regression Analysis.

Independent variable	Model I		Model II
	Estimate	Significance	Estimate	Significance
Intercept	−0.554	[<.01]	−0.164	(.10)
BAPCPA	−0.233	[<.01]	−0.186	(.01)
FINCRISES	−0.060	[.44]	0.154	(.22)
PREPACKED	0.175	[.01]	0.012	(.09)
OWNER	0.082	[.59]	−0.033	(.85)
PRICE	0.044	[.07]	0.035	(.18)
ASSETS	0.036	[.06]	0.040	(.05)
ZSCORE	0.016	[.29]	−0.042	(.01)
PDI	−0.017	[.48]	−0.025	(.52)
Reset (F test significance)	.66		.77
White (F test significance)	.02		.32
N	323		323
R ²	23.5%		17.5%

Note. Model I [II] is estimated using CARs computed over the (−1, +1) [(+2, +6)] event window as the dependent variable. BAPCPA is a dummy variable, set to one when the Chapter 11 case is initiated under the new Bankruptcy Code. FINCRISES is a dummy variable set to one when the Chapter 11 is initiated between September 15, 2008 and December 31, 2009. PREPACKED is a dummy variable set to one when the firm files a prenegotiated Chapter 11. OWNER is the percentage of shares held by institutional investors in the quarter leading up to the bankruptcy announcement date. PRICE is the natural log of the price per share in the day that precedes the bankruptcy announcement date. ASSETS is the natural log of total assets as of the fiscal year end preceding bankruptcy announcement year. ZSCORE is a bankruptcy-risk proxy, computed as in Altman (1968) with data from the last 10-K report disclosed prior to the bankruptcy announcement year. PDI is a predisclosure information proxy, measured as each firm’s market-adjusted CAR computed over the 3-month period preceding the bankruptcy announcement date. Reset (F test significance) is the Reset test’s p value. White (F test significance) is the White test’s p value. R² is the regression’s R-squared. N is the number of bankrupt firms used to estimate the model, using OLS. p values computed using standard [heteroskedasticity-robust] errors are reported in parentheses [brackets]. BAPCPA = Bankruptcy Abuse Prevention and Consumer Protection Act; OLS = ordinary least squares; CAR = cumulative abnormal return.

Moving on to the actual results, Table 8 shows that the estimated coefficient for BAPCPA in Model I is −0.233 (p < .01) and in Model II is −0.186 (p = .01). In light of this evidence, one can conclude that the regression results conform to the initial expectations. In particular, after controlling for other factors, ceteris paribus, shareholders of firms filing under the BAPCPA can expect to lose substantially more (i.e., up to 23.3%) in risk-adjusted terms around the event date than their pre-BAPCPA counterparts. Furthermore, all else being equal, firms filing under the new Code are likely to experience more negative abnormal stock returns (i.e., up to 18.6%) in the few days subsequent to the bankruptcy announcement date than firms seeking protection from creditors under the old 1978 Code.

As Table 8 shows, some of the control variables are also significant. For instance, in Model I, the estimated coefficient for PRICE is 0.044 (p = .07) and for ASSETS is 0.036 (p = .06). Thus, there is evidence to suggest that, ceteris paribus, smaller firms, and those trading at lower per share prices experience larger negative abnormal returns at their Chapter 11 date. However, in Model II, the estimated coefficients for ZSCORE and ASSETS are significant at normal levels (−0.042, p = .01 and 0.040, p = .05, respectively). This suggests that ceteris paribus, smaller firms, and those with lower levels of prefiling financial distress experience larger negative abnormal stock returns shortly after filing for Chapter 11. Importantly, in both Model I and II, the estimated coefficient for the dummy variable PREPACKED is positive and statistically significant. Recall that this variable assumes the unit value when a reorganization plan is prenegotiated in advance of the actual bankruptcy filing. Hence, the evidence in Table 8 suggests that, all else being equal, shareholders’ wealth is more penalized in risk-adjusted terms both at the Chapter 11 filing date and shortly after when firms do not contemporaneously announce that a reorganization plan is already agreed upon.

The estimated coefficients for OWNER and PDI are not statically significant in both Model I and II. This suggests that, once the other factors are accounted for, such variables have no incrementally power to explain the abnormal stock returns of the sample firms at and shortly after their Chapter 11 dates. A similar conclusion applies to the FINCRISES dummy variable. In effect, its estimated coefficient in Model I is −0.060 (p = .44) and in Model II is 0.154 (p = .22). As such, in line with the univariate results presented above, Table 8 suggests that a potential “Financial crises effect” does not confound this article’s original results.

Conclusion

A central tenet in economics is that competition among companies drives markets toward a state of long-run equilibrium in which goods are produced at minimal marginal cost. In the transition to such equilibrium, inefficient firms are forced out of the market. Modern societies deal with corporate failure by developing and implementing complex bankruptcy laws, which differ widely across countries. For instance, Germany and the United Kingdom are known for having “tough” bankruptcy laws, which grant considerable protection to creditors and favor the retrieval of secured loans over the survival of the business (e.g., Franks, Nyborg, & Touros, 1996; White, 1996). In contrast, the U.S. bankruptcy law is typically considered to be “soft” as, historically, it has provided significant latitude to debtors during bankruptcy proceedings (e.g., Fisher & Martel, 2008; Hotchkiss, John, Mooradian, & Thorburn, 2008; Kausar, Taffler, & Tan, 2017). The passing of the BAPCPA of 2005, however, justifies revisiting this traditional understanding. In effect, the new Code enacted or modified several business-related provisions, with some authors claiming that such changes created a sort of “creditor-in-possession” Chapter 11 model, which significantly limits debtors’ ability to control the proceedings and systematically depletes them of cash and time. Others, however, argue that the BAPCPA simply rationalized the bankruptcy process, having no effect on the business-bankruptcy landscape.

This article contributes to this debate by examining the stock price dynamics of a sample of 243 (80) firms that continue trading on the main U.S. stock exchanges after filing for Chapter 11 under the 1978 Bankruptcy Code (BAPCPA). It shows that, in the preevent period, equity holders experience a similar loss irrespective of the Code that governs the proceedings. Yet, there is a much stronger and negative market reaction to the formal announcement of Chapter 11 after the passing of the BAPCPA. Furthermore, the new Code severely affects how the market digests such bad news event as, on average, BAPCPA (non-BAPCPA) firms exhibit negative (positive) abnormal stock returns in the week that follows the Chapter 11 filing date. Together, these findings suggest the equity market perceives the BAPCPA as relatively more creditor-friendly than its predecessor, which is evidence in favor that the new Code introduced relevant changes in the U.S. business-related bankruptcy landscape.

In parallel, this article is also important as it is the first to explore the abnormal stock performance of firms filing for Chapter 11 before and after October 12, 2005. In a novel contribution to the literature, the present study shows that the market’s reaction to such an event becomes significantly more negative in the post-BAPCA period. Furthermore, this article is the first to show that market prices may continue to significantly plummet in risk-adjusted terms post event once the business-related innovations introduced by the BAPCPA are enacted. In fact, the previous evidence collected by Dawkins et al. (2007) and Schatzberg and Reiber (1992) for the pre-BAPCPA period suggests that, in certain circumstances, the market actually overreacts to the exact same corporate event. As such, this article highlights the importance of the legal framework to explain the stock price dynamics of distressed firms.

Footnotes

Author’ Note

I would like to thank the Editor, Bharat Sarath, for all his help and support, and two anonymous referees for their insightful comments. This article has also benefited from the comments, inter alia, of Abhay Abhyankar, Duarte Trigueiros, Efigénio Rebelo, Richard Taffler, Rúben Peixinho, and different anonymous participants at Research Seminars held at ISEG/UTL, University of Évora and University of the Algarve, University Pablo de Olavide and participants at the XIII Accounting and Auditing Congress. Luís M. Serra Coelho is also associated with the Center for Advanced Studies in Management and Economics, University of Évora.

Declaration of Conflicting Interests

The author(s) declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article.

Funding

The author(s) disclosed receipt of the following financial support for the research, authorship, and/or publication of this article: I acknowledge partial financial support from the School of Economics–University of the Algarve. I am also pleased to acknowledge that this paper is financed by National Funds of the FCT - Portuguese Foundation for Science and Technology within the project (UID/ECO/04007/2019).

Notes

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Business-Bankruptcy After the BAPCPA: Evidence From the Stock Market

Abstract

Keywords

Introduction

Literature Review

Market Reaction to Bankruptcy Announcements

BAPCPA and the U.S. Bankruptcy Law

Summary and Research Question

Data and Descriptive Statistics

Market Reaction to the Announcement of Chapter 11 Bankruptcy: Initial Evidence

Additional Tests

The 2008/2009 Financial Crises 8

Earnings Surprise

Momentum

Market Reaction to the Announcement of Chapter 11 Bankruptcy: Regression Analysis

Conclusion

Footnotes

Author’ Note

Declaration of Conflicting Interests

Funding

Notes

References

The 2008/2009 Financial Crises⁸