The Equity Performance of Firms Emerging from Bankruptcy

Abstract

This study assesses the stock return performance of 131 firms emerging from Chapter 11 between 1980 and 1993. Though there are some important differences, a firm issuing equity upon emergence from bankruptcy is analogous to an initial public offering (IPO). In contrast to the IPO literature, we find significant evidence of underpricing in the long-term. We also investigate reasons for cross-sectional differences in the returns. For example, we find that there is a positive relationship between the willingness of institutional investors to accept equity in the emerging firm (in exchange for their old claim on the formerly bankrupt firm) and the subsequent long-term equity returns. The results provide an interesting contrast, but not a contradiction, to previous work in this area that has documented poor operating performance for firms emerging from Chapter 11. 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 from Chapter 11.