The Micro and Macro Economics of Bad Bankruptcy

This dissertation is meant as an example of a broader research agenda. The agenda focuses on the role that Legal and Regulatory institutions play in determining economic failure as well as on their role in the subsequent (re)-allocation of productive resources. The broad goal is to investigate how institutions that underlie reallocation and adjustment processes in the economy can hamper or facilitate the flow of resources to their highest productive use. The research effort can be distinguished into two interconnected parts of inquiry: (1) the micro-economic study of institutions involved in determining economic failure and reallocation of productive resources, and (2) the study of the macro-economic impact of the functioning of these institutions.;Predicting failure in complex systems is difficult since failure often is the emergent result of several interconnected elements within that system. As such the question is not so much how we can prevent failure as more how we can fail well. In economic systems, several institutions are involved in determining what constitutes economic failure and subsequently how the resources involved in economic failure can be reallocated. The question is (1) how well these institutions perform the task of facilitating the flow of resources to their highest productive use and (2) what the Macro Economic consequences are of that functioning. The dissertation specifically investigates how corporate bankruptcy functions in this light.;The first chapter, entitled "The Effects of Legal Limbo on the Bankrupt Firm" argues that bankruptcy's institutional environment creates inertia and steers firm governance during bankruptcy away from profit maximization. Inertia is evidenced by significantly less variable firm (dis)investment during bankruptcy as compared to the matched industry counterparts. Importantly, given lengthy bankruptcy procedures, the firm's ability to recover out of bankruptcy---as measured by several financial indicators---is negatively affected by the length of bankruptcy procedures. The finding is especially relevant for recessions where the number of bankruptcies increases and thereby the length of bankruptcy court procedures. The connection between worsening financial performance and the length of bankruptcy procedures can be explained by the (1) lack of managerial monitoring of business processes during bankruptcy as well as (2) the lack of firm adaptation in terms of the firm's capital structure to the changing market environment during bankruptcy.;The second chapter entitled "Bankruptcy as Filtering Failure", investigates how well U.S. corporate bankruptcy procedures perform the task of distinguishing economically viable but financially failed firms from economically failed firms. Bankruptcy filtering failure constitutes a failure to facilitate the flow of resources to their most productive use. The question is important since firm exit rates yearly average around 10 percent while recessions feature more firm exits. I provide novel evidence that suggests the bankruptcy process is not able to distinguish between financially failed but viable firms and economically unviable firms. Specifically I show that firms emerging from bankruptcy do not exhibit performance catch-up behavior to their going concern industry counterparts as is expected from viable firms that are relieved from financial distress. Additional evidence on matched performance differences between bankrupt firms and industry counterparts indicate that there is no improvement in the performance gap between bankrupt firms and industry right before and after bankruptcy. Moreover, employing a logistic regression analysis of the determinants of bankruptcy survival, I find that the bankruptcy judge may be a source of filtering failure: Bankruptcies featuring more employees as well as with operations closer to the judge's district are more likely to emerge. The finding is important since the current dominant view of the bankruptcy process and possible filtering failure is based on the creditor conflict view.;The third chapter "Bankruptcy Filtering Failure and Recession Cleansing" is an example of how I envision the study of the macro-economic impact of institutions dealing with economic failure and reallocation of productive resources. In the paper I incorporate the possibility of bankruptcy filtering failure in a macroeconomic model of business dynamics. The model , originally designed by Osotimehin and Pappada (2015) , is a model based upon the study of business dynamics and firm exit supplemented with firm exit under credit frictions. The institutional addition to the business dynamics model illustrates the mechanism through which bankruptcy filtering failure diminishes the extent by which recessions are cleansing the pool of firms from the less productive establishments. The model shows that the degree to which recessions are cleansing depends on bankruptcy filtering accuracy. The recession cleansing effect worsens, when I incorporate the fact that firms with bigger asset valuations have a higher likelihood of bankruptcy survival.;The last chapter concludes. Overall the dissertation is an attempt to study the performance of institutions of reallocation in terms of dealing with economic failure and subsequent reallocation. It is my hope that the legal and regulatory structures that are vital in their influence on reallocative capacity of economies receive more attention in Macro Economics broadly and specifically in the Macro Economic modelling methodology.