The Equity Performance of Firms Emerging from Bankruptcy

Abstract

This study assesses the stock return performance of the 131 firms emerging from Chapter 11 between 1980 and 1993. Though there are some important differences, a firm issuing stocks upon emergence from bankruptcy is analogous to an initial public offering (IPO). Many studies have documented significant abnormal short-term positive returns accruing to IPO investors but more recent evidence suggests that IPOs are overpriced in the 1 to 3 years following issuance. We uncover some evidence that stocks of firms emerging from bankruptcy are underpriced in the short term; the average cumulative abnormal return (ACAR) is, depending on how expected returns are estimated, between 2.8% and 2.9% for the fist 2 days following emergence (the medians, though, range from 0.1% to 0.3%). In the first 200 trading days following emergence, the ACARs vary from 22.8% to 29.6% and the medians range from 16.8% to 22.2%. Our results are of broad interest for three main reasons. First, they cast doubt on the informational efficiency of this market. This is of particular interest to investors, primarily, bondholders, in formerly bankrupt firms that liquidate their equity position in the newly emerged firms or to investors who specialize in the purchase of post Chapter 11 equities. Second, the results are in stark contrast to the long-term underperformance observed in the IPO market. Finally, the results provide an interesting comparison with the operating performance of firms emerging from bankruptcy between 1979 and 1988 as documented by Hotchkiss (1995). The poor average operating performance she reports suggests that the Chapter 11 process does not efficiently screen out economically inefficient firms. Our results suggest that, although these firms may not achieve strong operating performance, they appear to do better than the market expected at the time they emerged form Chapter 11.