Financial Distress, Stock Returns, and the 1978 Bankruptcy Reform Act

Review of Financial Studies, Vol. 28, Issue 6, pp. 1810-1847
Dirk Hackbarth,
Rainer Haselmann,
David Schoenherr
Reseach Area:
Financial Institutions

We study the effect of weakening creditor rights on distress risk premia via a bankruptcy reform that shifts bargaining power in financial distress toward shareholders. We find that the reform reduces risk factor loadings and returns of distressed stocks. The effect is stronger for firms with lower firm-level shareholder bargaining power. An increase in credit spreads of riskier relative to safer firms, in particular for firms with lower firm-level shareholder bargaining power, confirms a shift in bargaining power from bondholders to shareholders. Out-of-sample tests reveal that a reversal of the reform's effects leads to a reversal of factor loadings and returns.

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