Bankruptcy Fire Sales

For more than two decades, scholars working from an economic perspective have criticized the bankruptcy reorganization process and sought to replace it with market mechanisms. In 2002, Professors Douglas G. Baird and Robert K. Rasmussen asserted in The End of Bankruptcy that improvements in the market for large public companies had rendered reorganization obsolete. Going concern value could be captured through sale. This Article reports the results of an empirical study comparing the recoveries in bankruptcy sales of large public companies in the period 2000 through 2004 with the recoveries in bankruptcy reorganizations during the same period. Controlling for company values measured at case commencement and operating profits, the recoveries in reorganization cases are more than double the recoveries from going concern sales. The authors attribute the low recoveries in sale cases to continuing market illiquidity, managers’ and professional advisors’ conflicts of interest, and the corruption of the bankruptcy process by competition among bankruptcy courts for large public company cases. As a result, debtors agree to sell at low prices, the auctions are rushed, and in most cases only a single bidder participates. The authors also report other sale characteristics. Bankruptcy recoveries are higher when debt capacity in the debtor’s industry is lower-the opposite of the effect predicted by Professors Andrei Shleifer & Robert W. Vishny in their landmark article in 1992. Cases in which debtors sell their companies as going concerns often in the first few months-on average remain pending significantly longer than reorganization cases. Bankruptcy recoveries are high in years when merger and acquisition activity is high for reasons other than high stock prices. Lastly, the number and proportion of bankruptcy sales have sharply declined in the past two years, suggesting that the sale era may be ending.