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The Irrelevance of Direct Bankruptcy Costs to the Firm's Financial Reorganization Decision

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Abstract:

We estimate the costs of reorganization and liquidation using firm-level data on 622 commercial bankruptcies filed under Canadian law (324 liquidating firms and 298 reorganizing firms). Using a hedonic pricing model of bankruptcy costs, we find the costs of liquidation and reorganization depend on firm size, the complexity of the case, and the ability of the bankrupt firm to pay. The central finding is that, contrary to theory, 40 percent of the firms opted either for reorganization or liquidation even though it was more expensive. We conclude that rational firms must base their bankruptcy decision on factors other than direct bankruptcy costs.

Document Type: Research Article

DOI: http://dx.doi.org/10.1111/j.1740-1461.2005.00034.x

Affiliations: University of Sydney;

Publication date: March 1, 2005

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