Working Papers

Can Strong Creditors Inhibit Entrepreneurial Activity? (with Nuri Ersahin and Rustom Irani) Review of Financial Studies, 2020

We examine entrepreneurial activity following the staggered adoption of modern-day fraudulent transfer laws in the United States. These laws strengthen unsecured creditors’ rights and are particularly important for entrepreneurs whose personal assets commingle with the firm’s. Using administrative data from the U.S. Census Bureau, we document declines in startup entry—particularly among riskier entrants—and closures of existing firms after these laws pass. Firm financial data shows that entrepreneurs lower leverage by reducing demand for unsecured credit. Our results suggest that strong creditor protections can limit entrepreneurs’ appetite for risk, which may reduce churning along the extensive margin among the smallest firms in the economy.

Unearthing Zombies (with Nirupama Kulkarni, S. K. Ritadhi, and Siddharth Vij)

The secular rise of “zombie” borrowers – insolvent firms sustained by continued extension of credit by complicit banks – has been a source of concern for mature and emerging economies alike. Using supervisory data on the universe of large bank-borrower relationships in India, we introduce a novel method for identifying zombies. We use this classification to test the effect on zombie recognition of two key reforms: an overhaul of the bankruptcy law and a regulatory intervention removing lender discretion in bad loan recognition. Increases in the recognition of zombie accounts as non-performing were modest after the law change but there was a more sizable increase post the regulatory action. We show that the effect of the bankruptcy law was concentrated among well-capitalized private banks; the regulatory action was required for undercapitalized and public-sector banks to respond. Post-intervention results indicate that lending has been reallocated to large, healthy borrowers. Overall, our results suggest that regulatory action might be necessary, above and beyond bankruptcy reform, to target “zombie” lending in the presence of weak banks and cronyism.

Cashing Out: The Rise of M&A in Bankruptcy (with Stuart C. Gilson, Edith S. Hotchkiss, and Matthew G. Osborn)

The use of M&A in bankruptcy has increased dramatically, leading to concerns that Chapter 11 leads to excessive liquidation of viable firms. We examine the drivers of M&A activity, based on factors specific to Chapter 11 as well as more general factors that drive M&A waves for non-distressed firms. M&A in bankruptcy is counter-cyclical, and is more likely when the costs of financing a reorganization are greater than financing costs to a potential acquirer. Consistent with a senior creditor liquidation bias, the greater use of secured debt leads to more sales in bankruptcy, but this result holds only for sales that preserve going concern value. We also show that overall creditor recovery rates are higher for firms with more secured debt, and that recoveries and post-bankruptcy survival rates are not different when bankrupt firms sell businesses as going concerns versus reorganizing independently. Our results are consistent with the efficient redeployment of assets via sales in bankruptcy.

Common Ownership and Startup Growth (with Ofer Eldar and Jillian P. Grennan) Under Review

Many startups are commonly-held by the same venture capital (VC) investors. We exploit the staggered introduction of liability exemptions when investors hold stakes in conflicting business opportunities as a shock to common ownership. We find increases in common ownership and directors serving on rivals’ boards after the law changes. Despite the potential for rent-extraction, commonly-held startups benefit by raising more capital through more investment rounds. Moreover, they are less likely to fail and exit more successfully through IPOs or acquisitions by another commonly-held startup. These successful startup outcomes are linked to VC directors serving on other startup boards.

How Do Firms Use Chapter 11? A Taxonomy

The U.S. Bankruptcy Code has been in place for four decades. In this time, a sophisticated cast of distress market participants has arisen and courts have worked to achieve transparency and verifiability in asset valuation. It is a puzzle, therefore, that corporations in the U.S. should file for bankruptcy at all. This paper constructs an empirical taxonomy of large Chapter 11 debtors based on their objectives and preparation at the time of filing. Approximately two thirds of the firms in the sample set out to reorganize while the remaining third aim to sell substantially all of their assets, either as a going concern or in liquidation. Nearly 60% of firms enter bankruptcy having undergone a thorough marketing of their assets or with a pre-arranged plan of reorganization in place. These findings suggest that, while the majority of large corporations use Chapter 11 to cure hold-outs or capture direct financial benefits afforded by the Bankruptcy Code, some cases may still involve strategic gaming and the exploitation of informational frictions.

Unsecured Creditor Control in Chapter 11

In Chapter 11 bankruptcy, certain control rights are assigned to an official committee of unsecured creditors. This paper investigates the impact of the official committee on Chapter 11 outcomes using a novel dataset built from raw court documents that covers all cases from 2004-2014 with over $10 million in assets. We find that the existence of an official committee is associated with a 7-11% increase in the likelihood that the firm is acquired. It also leads to a reduction in the amount of time spent in bankruptcy, particularly for firms that end up acquired. In addition to the main results, we also find that membership composition matters and that certain influential creditors are associated with higher rates of reorganization when they are present on the official committee.

 

WORKS IN PROGRESS

Restructuring Support Agreements: An Empirical Analysis (with Anthony J. Casey and Frederick Tung)

Are COVID-19 Disclosures Informative? (with Rohan Williamson)

Negotiation and Control in Chapter 11

 

Policy

The Budgetary Impact of Ending Drug Prohibition with Jeffrey Miron (2010)

State and federal governments in the United States face massive looming fiscal deficits. One policy change that can reduce deficits is ending the drug war. Legalization means reduced expenditure on enforcement and an increase in tax revenue from legalized sales. This report estimates that legalizing drugs would save roughly $41.3 billion per year in government expenditure on enforcement of prohibition. Of these savings, $25.7 billion would accrue to state and local governments, while $15.6 billion would accrue to the federal government. Approximately $8.7 billion of the savings would result from legalization of marijuana and $32.6 billion from legalization of other drugs. The report also estimates that drug legalization would yield tax revenue of $46.7 billion annually, assuming legal drugs were taxed at rates comparable to those on alcohol and tobacco. Approximately $8.7 billion of this revenue would result from legalization of marijuana and $38.0 billion from legalization of other drugs.