The Choice Among Traditional Chapter 11, Prepackaged Bankruptcy,and Out-of-Court Restructuring

I examine how financially distressed firms choose among three alternatives: traditional Chapter 11 bankruptcy, prepackaged bankruptcy, and out-of-court restructuring. In doing so, I investigate firm performance and capital structure, as well as the previously undocumented role of managerial discretion. My sample consists of 198 observations and 174 poorly performing firms that start restructuring between 1988 and 1999 using one of these three alternatives. Results suggest that the primary determinant of the restructuring choice is firm performance. Specifically, logit regressions show that firms are significantly more likely to restructure out-ofcourt rather than in traditional Chapter 11 bankruptcy when they come from industries with higher median market-to-book ratios and when they have a higher ratio of operating income to total assets in the year before the onset of financial distress. On the other hand, firms restructuring out-of-court also exhibit a significantly greater number of long-term debt contracts per dollar of total debt in the year before distress and a significantly greater increase in the ratio of long-term debt to total assets over the two years prior to distress, compared to firms entering traditional Chapter 11 bankruptcy. There is no evidence to suggest that managerial ownership and monitoring by the board of directors and unaffiliated equity blockholders play a significant role in the restructuring decision.