Finance Brown Bag Seminar: Guangqian (Isaac) Pan
Pre-packaged reorganization (prepack) during Chapter 11 bankruptcy has been praised for shortening the process and lowering bankruptcy costs. We propose an information acquisition model where creditors trade off higher bankruptcy costs under traditional reorganization with the benefits of higher accuracy in filtering inefficient from efficient firms, where the decision to prepack is governed by the value of the signal a firm is able to acquire under traditional bankruptcy. Our empirical evidence supports these predictions. Namely, firms choosing traditional reorganization are typically those with precise information signals (i.e., low intangible assets) and higher downside risk (i.e., lower Z-score). These firms subsequently have a lower rate of emergence from traditional Chapter 11 but a higher survival rate conditional on emergence. This result is robust to the inclusion of controls for industrial distress, economic downturns, CEO turnover, professional costs, DIP financing and several judicial variables. Interestingly, direct costs in traditional Chapter 11 do not lower firms’ survival rate, but direct costs in prepack increase firms’ refilling rate.