Asset Reallocation in Bankruptcy

This paper investigates the consequences of Chapter 7 liquidation and Chapter 11 reorganization on the reallocation and subsequent utilization of assets in bankruptcy. We identify 129,000 bankrupt establishments and construct a novel dataset that tracks the occupancy and utilization of real estate assets over time. Asset reallocation is widespread, as nearly 80% of real estate is not occupied by bankrupt owners ve years after the bankruptcy ling. We use the random assignment of judges to bankruptcy cases as a natural experiment that forces some rms into Chapter 7, despite their initial Chapter 11 ling. Relying on such variation as an instrumental variable, we nd that real estate assets in Chapter 7 are 17.4% more likely to be vacant and employ 34% less workers in the ve years after bankruptcy ling than comparable plants that remain in Chapter 11. These e ects are concentrated in thin local asset markets with few potential buyers. In contrast, no di erences in asset utilization occur in thick asset markets, highlighting the importance of local markets and asset speci city in resolving nancial distress. ∗Shai Bernstein ([email protected]) is from Stanford University, Graduate School of Business and NBER; Emanuele Colonnelli ([email protected]) is from Stanford University; and Benjamin Iverson ([email protected]) is from Northwestern University, Kellogg School of Management. We thank Darrell Du e, Dirk Jenter, Pete Klenow and seminar participants at Maastricht University, Tilburg University, the Finance UC Conference (Ponti ca Universidad Catolica de Chile) and brownbag participants at Stanford and Northwestern Universities for helpful comments and suggestions. Any opinions and conclusions expressed herein are those of the authors and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no con dential information is disclosed. Asset reallocation between rms is an important determinant of the economy's speed of recovery following adverse shocks. Nevertheless, asset reallocation occurs procyclically, suggesting signi cant costs or frictions prevent reallocating assets during economic downturns (Eisfeldt and Rampini (2006)). The bankruptcy system plays an important role in reallocating assets, particularly during economic downturns. Bankruptcy institutions typically fall into one of two distinct regimes: liquidation or reorganization. In liquidation (such as Chapter 7 of the U.S. bankruptcy code), the rm ceases to exist and assets are sold in cash auctions. In reorganization (such as Chapter 11 in the U.S.), the rm continues to operate, and a structured bargaining process determines whether assets remain under existing ownership or are divested. Despite the prevalence of bankruptcy in the economy, relatively little is known about the e ects of these two approaches on asset reallocation. This paper attempts to ll this gap by comparing how assets are reallocated and ultimately utilized in Chapter 7 and Chapter 11 bankruptcy regimes. Theoretically, with frictionless markets the outcomes of Chapter 7 liquidation and Chapter 11 reorganization should be identical and both systems should e ectively allocate capital to its best use. However, various frictions may lead either Chapter 11 reorganization or Chapter 7 liquidation to ine cient outcomes. Speci cally, while Chapter 11 provides the exibility to choose which assets to keep within a rm and which to sell, previous work has shown that con icts of interest, information asymmetry, and coordination costs can lead to complicated and costly negotiations that erode the value of the estate and prevent assets from reallocating to better uses (Gertner and Scharfstein (1991); Baird (1986, 1993); Bebchuk (1988); Ivashina et al. (2015)). Meanwhile, Chapter 7 avoids both ine cient continuation and costly negotiation by forcing the liquidation of the rm. However, when asset markets are illiquid, forced liquidations can result in assets not ending up at their highest-value use, particularly when assets are speci c to a particular rm or industry (Williamson (1988)). Such misallocation may be further exacerbated by the correlation of nancial distress with industry-wide downturns, in which optimal buyers may not be able to bid for the bankrupt rm assets (Shleifer and Vishny (1992)). Because theory suggests that both structured bargaining and forced liquidation might lead to ine cient outcomes, ultimately, the e ects of bankruptcy regimes on asset realloca-