Accounts Receivable, Trade Debt and Reorganization

The optimal outcome of a firm in bankruptcy is to liquidate if its asset value is greater than its value as a going concern or, alternatively, to reorganize if it is worth more as a going concern. In this study, we identify firm asset and liability characteristics which may determine the likelihood of a firm successfully emerging from bankruptcy. We find two key factors influencing the success of a bankruptcy: the ratio of the firm’s accounts receivable to its total debt, and the ratio of its accounts payable to total debt. Controlling for size, the probability of a firm successfully reorganizing is found to be positively related to the ratio of accounts receivable to total debt, and negatively related to the ratio of accounts payable to total debt. The evidence indicates that accounts receivable are a valuable source of cash to pay creditors in bankruptcy, and that trade creditors may be more supportive of liquidation than other creditors even though liquidation eliminates the opportunity to conduct future business with the firm.