Working Paper: CEPR ID: DP16844
Authors: Assaf Hamdani; Yevgeny Mugerman; Ruth Rooz; Nadav Steinberg; Yishay Yafeh
Abstract: We study the effects of a court decision granting creditors the power to force into bankruptcy corporate debtors whose liabilities exceed their assets even if they are current on their payments. We find that bond prices responded positively to the court ruling, perhaps because of expectations that early resolutions of future cases of financial distress would benefit creditors. We also find that firms affected by the court ruling did not reduce their risk, but increased their reported net worth through equity injections and aggressiveaccounting. As a result, the informativeness of these firms’ financial statements decreased. Although it may well be the case that the overall effect of the court ruling on social welfare was positive, we argue that empowering creditors to force firms into bankruptcy using a balance sheet test for insolvency may involve adverse effects,increasing borrowers’ incentives to present biased financial statements.
Keywords: bankruptcy; creditor rights; financial distress; informativeness; aggressive accounting
JEL Codes: G30; G33; K22; M41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Court ruling (K40) | Creditor empowerment (G33) |
| Court ruling (K40) | Bond prices of affected firms (G32) |
| Court ruling (K40) | Stock prices of affected firms (G10) |
| Court ruling (K40) | Corporate risk (G32) |
| Court ruling (K40) | Net worth of treated firms (G32) |
| Net worth of treated firms (G32) | Fraction of firms with negative net worth (G32) |
| Court ruling (K40) | Equity injections (O16) |
| Court ruling (K40) | Aggressive accounting practices (M48) |