A key goal of Chapter 11 is to provide economically viable firms an opportunity to reorganize, while liquidating those that are not viable. There has been considerable debate as to whether the current bankruptcy code strikes the right balance between reorganization and liquidation, or whether it is biased toward allowing inefficient firms to reorganize. The number of failures following Chapter 11, as seen in the significant number of Chapter 22 filings, might be taken as evidence of a problem with the structure of Chapter 11. At the same time, we have seen some spectacular success stories upon emergence from bankruptcy, at least from the perspective of equity holders in the reorganized company. For example, Kmart's common stock traded at under $14 per share when the firm emerged from Chapter 11 in May 2003, with 53% of its shares owned by ESL Investments. The stock rose more than seven times to over $100 per share by November 2004, when its merger with Sears was announced (the longer term fate of the merged company was, of course, less stellar, leading to its bankruptcy filing in 2018). Six Flags emerged from Chapter 11 in 2010, with its stock trading at less than $10 per share; as the firm underwent a successful operational restructuring, the stock price approximately doubled in the first postbankruptcy year and continued to increase thereafter.
There are several ways in which one might evaluate the success of Chapter 11. The simplest measure of a “successful” restructuring might be whether the firm in fact emerges from the process as a going concern. For firms that do emerge, researchers have examined several measures of postbankruptcy success. This chapter describes recent evidence on bankruptcy outcomes and postbankruptcy performance, and their relevance to the debate over the efficiency of Chapter 11.
When a firm enters Chapter 11, the expected outcome in most cases is to confirm a plan under which the firm is reorganized (or sometimes sold) as a going concern. However, only a fraction of firms that enter Chapter 11 emerge as independent companies. The Executive Office for United States Trustees provides comprehensive national analysis of the confirmation rates of Chapter 11 cases, and periodically publishes analyses of case outcomes. The most striking facts emerging from their analysis are the following:
Confirmation rates for all national Chapter 11 cases since 2008 are provided in Figure 7.1.
| Fiscal Year Filed | Total Cases Files | Total Confirmed | Percent Confirmed(1) |
| 2008 | 8,869 | 2,934 | 33.1% |
| 2009 | 14,816 | 5,892 | 39.8% |
| 2010 | 14,296 | 5,110 | 35.7% |
| 2011 | 12,115 | 4,186 | 34.6% |
| 2012 | 10,678 | 3,902 | 36.5% |
| 2013 | 9,679 | 3,573 | 36.9% |
| 2014 | 7,691 | 2,434 | 31.6% |
| 2015 | 7,110 | 1,918 | 27.0% |
| 2016 | 7,494 | 1,515 | 20.2% |
| 2017(2) | 7,100 | 572 | 8.1% |
(1) Confirmation rates may be slightly understated because cases that were dismissed or converted after confirmation but before closing are not counted as confirmations.
(2) As of September 30, 2017.
FIGURE 7.1 National Chapter 11 Filing and Confirmation Figures by Year since 2008
Source: Federal Judicial Center, based on reports from the Administrative Office of the U.S. Courts (https://www.fjc.gov/research/idb).
These figures include all national filings, not only those of publicly registered companies. A caveat in interpreting these figures, however, is that large companies entering Chapter 11 often file a number of bankruptcy petitions for the various entities within their firm, and each individual case is treated as a separate observation in this analysis. For example, in early 2004, Footstar Inc. filed in the Southern District of New York. This case included approximately 2,510 separate filings—about 20 percent of all of the Chapter 11 cases filed nationwide that year. While the number of related cases is generally not nearly as extreme as for Footstar, this problem does lead to an overstatement of confirmation rates, since bigger cases with a number of related filings are more likely than average to reach confirmation. Still, it is clear that well over 60% of cases are closed without confirmation. A likely explanation is that the direct and indirect costs of distress and bankruptcy make reorganization in bankruptcy infeasible for many smaller firms (Bris, Welsh, and Zhu 2004).
Confirmation rates are particularly useful in understanding the outcomes of cases for smaller firms. For larger firms entering Chapter 11, further classifications of case outcomes describe of how assets are redeployed. Broadly, there are four economic outcomes to a Chapter 11 bankruptcy case:
Much of what we know about Chapter 11 case outcomes is, by necessity, based on studies of public companies that have entered Chapter 11. An exception is Waldock (2017), who uses information from PACER to examine 2,621 Chapter 11 cases between January 2004 and July 2014 with assets of at least $10 million (based on the bankruptcy petition). Of the firms in her study, 33.3% of firms are reorganized, 15.8% acquired, 21.5% liquidated, and 27.1% dismissed. The relatively high rates of liquidation and dismissals are likely due to the inclusion of smaller firms than previous studies based on firms reporting financial statements (from SEC filings, as reported to Compustat) prior to filing.
In a study of over 3,000 public companies entering Chapter 11 between 1981 and 2013, Altman (2014) reports that 65% of firms either emerge as a continuing entity or are acquired. Similarly, Iverson, Madsen, Wang, and Xu (2018) find that 57% of firms filing from 1980 to 2012, with assets of at least $50 million, emerge from Chapter 11. Earlier studies report similar statistics, showing that larger public companies have a significantly greater likelihood of emerging or being sold as a going concern. Firms that are liquidated after failed efforts to reorganize are typically smaller firms, but do include some well‐known large failures such as Circuit City. These firms spend several months or longer in Chapter 11 before they move to Chapter 7 or a liquidating Chapter 11 plan.
A relatively small number of firms merge with another operating company under a plan of reorganization. Hotchkiss and Mooradian (1998) find that mergers are an effective mechanism for redeploying the assets of Chapter 11 firms, in the sense that the combined cash flows of the merged company after Chapter 11 increase by more than is observed for similar nonbankrupt transactions. It is significantly more likely that acquisitions occur using Section 363 of the bankruptcy code (see Chapter 3 here in and discussion below).
Several researchers have tried to identify factors that are related to the probability a firm successfully emerges from Chapter 11. One of the first such attempts was Hotchkiss (1993). The overwhelmingly most important firm characteristic related to whether firms successfully reorganized rather than liquidated was firm size, measured by the prepetition assets of the company. Hotchkiss shows that many of the emerging firms have considerably downsized while in Chapter 11, so that the ability to divest assets and use the proceeds to fund remaining operations is likely to be important in understanding why these firms are more likely to survive Chapter 11. Dahiya, John, Puri, and Ramirez (2003) argue that the availability of debtor‐in‐possession (DIP) financing to large companies is an important determinant of the reorganization versus liquidation outcome. Consistent with these studies, Denis and Rodgers (2007) focus on events during the Chapter 11 process and show that firms that both reduce their assets and liabilities while in Chapter 11 are more likely to emerge as an independent firm.
If Chapter 11 does in fact suffer from economically important biases toward continuation of unprofitable firms, poor investment decisions will be reflected in the postbankruptcy performance of firms emerging from the process. Therefore, researchers have found it useful to examine several dimensions of post‐emergence performance:
These studies are, by necessity, based on firms that survive Chapter 11 as publicly registered companies. Existing studies of performance of firms emerged from Chapter 11 are summarized in Figure 7.2, and described in the remainder of this section.
| Operating Performance | Ability to Meet Cash Flow Projections | Stock Performance | Sample | |
| Hotchkiss (1995) | √ | √ | √ | 197 firms emerging by 1989 |
| Hotchkiss and Mooradian (2004) | √ | √ | 620 firms emerging by 2004 | |
| Maksimovic and Phillips (1998) | √ | Plant level data for 302 manufacturing firms in Chapter 11 1978–1989 | ||
| Alderson and Betker (1999) | √ | 89 firms emerging from Chapter 11 1983–1993 (includes 62 emerging 1990–1993) | ||
| Hotchkiss and Mooradian (1997) | √ | 288 firms defaulting on public debt 1980–1993 (166 are reorganized in Chapter 11) | ||
| Michel, Shaked, and McHugh (1998) | √ | 35 firms filing for Chapter 11 from 1989 to 1991 | ||
| Betker, Ferris, and Lawless (1999) | √ | 69 firms emerging from Chapter 11 1984–1994 | ||
| Eberhart, Altman, and Aggarwal (1999) | √ | 131 firms emerging from Chapter 11 as a public firm from 1980 to 1993 | ||
| Goyal, Kahl, and Torous (2003) | √ | Firms distressed between 1980 and 1983; 35 firms in first year after resolution of distress to 25 firms five years after | ||
| Jiang and Wang (2019) | √ | 266 Chapter 11 cases filed by U.S. firms with at least $50m assets at filing and that emerged as a public firm from 1982 to 2013 |
FIGURE 7.2 Academic Studies of Postbankruptcy Performance
The first comprehensive analysis of postbankruptcy operating performance was Hotchkiss (1995), who examined firms that emerged as public companies from Chapter 11 by 1989. These firms had an average book value of assets prior to filing of $285 million, were generally insolvent at the time of filing, and spent on average 1.7 years in bankruptcy. The financial performance of each firm was traced for up to five years following the time of emergence from bankruptcy.
This early analysis produced some striking results. Over 40% of the firms emerging from bankruptcy continued to experience operating losses in the three years following bankruptcy. Based on accounting ratios such as return on assets and profit margins, performance was substantially lower than for matched groups of firms in similar industries. For example, in the year following emergence from Chapter 11, almost three quarters of the sample firms have a ratio of operating income to sales that is lower than observed for nonbankrupt firms in the same industry. The firms showed some positive growth in revenues, assets, and number of employees in the postbankruptcy period, but showed little improvement in profitability, especially in comparison to industry groups. Performance varied little over the five‐year postbankruptcy period, which suggests the firms did not simply need more time to recover.
This analysis has been confirmed for a subsequent time period by Hotchkiss and Mooradian (2004). The most significant difference from the earlier study is that larger firms, which become more prominent in later sample years, have somewhat better performance based on these accounting measures. Still, for even the larger firms in the updated sample, more than two‐thirds of the firms underperform industry peers for up to five years following bankruptcy, and over 18% of the sample firms have negative operating income in the year following emergence. Denis and Rodgers (2007) also study postbankruptcy operating performance, and show that operational restructuring during bankruptcy is associated not only with a greater likelihood of emergence, but a higher industry adjusted operating performance following emergence.
An important concern in interpreting any analysis of postbankruptcy performance based only on firms that survive Chapter 11 is the fact that firms' asset composition changes significantly before and during bankruptcy. Maksimovic and Phillips (1998) examine this issue by studying plant‐level operating data for manufacturing firms in Chapter 11 between 1978 and 1989. They examine measures of productivity of capital, as well as operating cash flow, for 1,195 plants of 302 bankrupt firms, as well as plants of nonbankrupt counterparts. Since they are able to track the productivity of individual plants, regardless of whether these plants are redeployed to new owners or are closed, Maksimovic and Phillips are able to examine asset performance even for firms that are liquidated or emerge private from Chapter 11, thus avoiding survivorship bias.
For the manufacturing firms they study, changes in bankrupt firms' performance can be explained for the most part by asset sales and closures, not by changes in the efficiency of retained assets. Bankrupt firms in high growth industries are more likely to sell assets than bankrupt firms in declining industries. The plants that are not sold by these firms have lower productivity compared to those that are sold off. In contrast, for nonbankrupt firms in the same industry, plants retained have significantly higher productivity than those sold. This result provides an alternative explanation as to why operating performance of emerging firms does not improve from prebankruptcy levels, namely that some firms have retained their least profitable assets. Further, in high growth industries, the productivity of the assets sold increases under new ownership. This evidence is consistent with the efficient redeployment of assets to more productive uses.
A key insight of the Maksimovic and Phillips study is that industry conditions are an important determinant not just of the frequency of bankruptcy, but of economic decisions such as asset redeployment in bankruptcy. In contrast to higher growth industries, in declining industries, the productivity of plants in Chapter 11 and subsequent to emerging does not significantly differ from their industry counterparts. This finding remains even when controlling for the changing asset composition of bankrupt firms as they make decisions to retain, sell, or close plants.
A final issue in evaluating whether firms return to profitability after Chapter 11 concerns the ownership and governance of the postbankruptcy firm. Hotchkiss and Mooradian (1997) find that the involvement of distressed debt investors, which rose dramatically starting in the early 1990s (see Chapters 3 and 14 herein), is strongly related to postbankruptcy success. Their study is based on a sample of 288 firms that defaulted on public debt between 1980 and 1993. The percentage of firms experiencing negative operating income in the year following bankruptcy is 31.9% for firms with no evidence of vulture involvement, versus 11.7% when a vulture has been involved in the restructuring. Strikingly, when the investor remains active in the governance of the firm post–Chapter 11, the percentage of firms experiencing operating problems drops to 8.1%. Improvements in performance relative to predefault levels are greater when the investor joins the board, becomes the CEO or Chairman, or gains control of the firm. When there is evidence of vulture involvement but the vulture is not subsequently active in the restructured company, performance appears no better than for those firms with no evidence of vulture involvement. Thus, the presence of these investors in the governance of the restructured firm is strongly related to postbankruptcy success for the sample studied. Distressed debt investors, largely hedge funds, has become the norm in most large Chapter 11 cases, and a number of firms emerging from Chapter 11 become portfolio companies of some of these investors. The post‐emergence performance and changes in value of these portfolio companies, which are privately held following the bankruptcy, remains a question for further study.
In order for a plan of reorganization to be confirmed by the court, the debtor must show that the plan is feasible. To meet this requirement, many firms provide cash flow forecasts, generally prepared by management or their financial advisors, when the plan is submitted to creditors and the court. The ability to meet these projections provides another measure of postbankruptcy success.
Cash flow projections are typically provided in the firm's disclosure statement, as part of the effort to gain creditor approval of the reorganization plan. Although the court has reviewed and approved these statements, it can still be difficult for outsiders to assess the validity of projections. First, the quantity and quality of financial information produced for firms in Chapter 11 may be reduced relative to prebankruptcy levels. For example, security analysts have often reduced coverage of these firms, and some firms cease to report audited financial statements. Second, the various constituencies involved in the case including management and various creditor groups can have divergent interests; the cash flow forecasts and the values they imply can arise either from negotiations among these parties, or from the group that largely controls the process.
Ex‐post comparisons of projected versus realized cash flows were examined in earlier studies, each of which found that firms, on average, failed to achieve their projections. In her study of postbankruptcy performance, Hotchkiss (1995) shows that projections were on average overly optimistic. For example, operating income was lower than projected for 75% of the 72 sample firms for which cash flow projections are available. However, shortfalls between projected and actual performance were significantly greater when prebankruptcy managers were still in office at the time the plan was submitted. If management is concerned with the firm's survival, they may need to convince creditors and the court that the firm value is high enough to justify reorganization rather than liquidation. A shareholder‐oriented management might also overstate forecasts in order to justify giving a greater share of the reorganized stock to prepetition equity holders.
Similar evidence demonstrating that firms on average are unable to meet cash flow projections is provided by Michel, McHugh, and Shaked (1998) and Betker, Ferris, and Lawless (1999). These researchers conclude that these forecasts have a systematic, optimistic and inaccurate bias in favor of reorganization.
Developments in the activity of distressed debt investors since the time of these studies have changed the dynamics of negotiations between stakeholders, and there have been notable instances of firms being undervalued at emergence based on projected cash flows. Gilson, Hotchkiss, and Ruback (2000) discuss incentives for over‐ (under‐) valuation, based on the successful influence of junior (senior) stakeholders. Thus, one might expect a greater number of cases of understated cash flow projections in some recent cases.
The high rate of Chapter 22 filings is not a new phenomenon, and has persisted since the early years of Chapter 11. Many repeat filers first entered bankruptcy in the wave of the early 1990s, and reentered in the bankruptcy waves of the early and late 2000s. Several early studies of postbankruptcy performance demonstrated the striking incidence of distressed restructuring taking place after firms have left bankruptcy. For example, Hotchkiss (1995) finds 32% of her sample firms restructure again either through a private workout, a second bankruptcy, or an out‐of‐court liquidation. Similar findings have been provided by LoPucki and Whitford (1993), Gilson (1997), and Halford, Lemmon, Ma, and Tashjian (2017). As shown in Chapter 1 herein, through 2017, an estimated 20% of all firms emerging from Chapter 11 as a going concern have subsequently refiled for bankruptcy.
The high rate of subsequent failures occurs despite requirements of the Bankruptcy Code that, in order for a reorganization plan to be confirmed, the company must demonstrate that further reorganization is not likely to be needed. Section 1129(a)(11) of the Code specifies: Confirmation of the plan is not likely to be followed by the liquidation, or the need for further financial reorganization of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan. High recidivism arguably runs counter to this requirement. Altman (2014) suggests that default prediction models, such as those explained in Chapter 11 herein, can be helpful in identifying firms with high risk of a subsequent failure.
There are several potential explanations for this high rate of subsequent failures. Many uncontrollable events, such as a major economic downturn, can lead to recidivism. Among the Chapter 22 or 33 filers are a number of airline, steel and textile companies, clearly reflecting difficult industry conditions. Still, subsequent failures have frequently occurred within two to three years after exiting the first Chapter 11, and additional factors likely contribute. For example, former Fortune 500 company Pillowtex (manufacturer of Fieldcrest sheets and towels) reorganized and emerged from its first bankruptcy in May 2002, then refiled for Chapter 11 in July 2003, and immediately announced it would liquidate. The firm immediately failed to meet the operating projections that the first bankruptcy's reorganization plan was based on, and it became clear that reorganized firm was not viable.
One factor explaining recidivism is that many firms have not sufficiently reduced their debt under their first restructuring plan. Supporting this idea, Gilson (1997) finds that firms remain highly levered after emerging from Chapter 11, though not as high as for those firms which complete an out of court restructuring: the median ratio of long term debt to the sum of long term debt and common shareholders' equity is 0.47. Another potential explanation is that the debtor's management is overly optimistic about the prospects for the reorganized firm, as reflected in overly optimistic cash flow forecasts (Hotchkiss, 1995).
While only a portion of firms entering Chapter 11 emerge as an independent, publicly registered company, an even smaller fraction of these firms successfully relist their stock following emergence. For example, of the 197 emerging firms studied by Hotchkiss (1995), only 60% had their stock relisted on NYSE/Amex or Nasdaq following emergence. She finds positive unadjusted but negative market adjusted stock returns for the year following emergence from bankruptcy. A large proportion of emerging firm stocks trade only on the OTC Bulletin Board or Pink Sheets, and so are not reflected in these studies. If the ability to relist the company's stock is a reflection of its postbankruptcy success, this might bias studies of postbankruptcy stock performance toward better performing firms.
Still, studying the performance of this group of stocks is interesting for several reasons. Most generally, it allows us to test the efficiency of the market for stocks of emerging firms, and is of particular interest to potential investors. More specific to our evaluation of the Chapter 11 process, it allows us to assess the accuracy of valuations of firms as projected in reorganization plans, by comparing the plan based valuation to the actual traded market value of the emerging firm. Further, creditors who receive stock as part of a reorganization plan but do not plan to hold the stock long term have a need to understand this market.
The first comprehensive academic study to date of the equity performance of firms emerging from bankruptcy is Eberhart, Altman, and Aggarwal (1999). Examining a sample of 131 firms emerging from Chapter 11 between 1980 and 1993, their key result is that there are large positive excess returns in the 200 days following emergence. A key issue in estimating these returns is the benchmark comparison or “expected return” from which to calculate abnormal performance. However, their results are robust with respect to different methods of estimating expected returns. Under their most conservative estimates, the average cumulative abnormal return over the first 200 days following emergence is 24.6% (median is 6.3%). Overall, they conclude that while returns in the first two days following emergence are not clearly significant, there are large positive and significant abnormal returns in the year following emergence.
More recent evidence on the stock performance post–Chapter 11 is provided by Jiang and Wang (2019), who report returns for 266 stocks (22% of their initial sample of Chapter 11 filings) of firms whose stock is traded on an exchange or over‐the‐counter after emergence. Median abnormal returns, relative to various benchmarks, reach 8% to 9% for horizons of one to three years after emergence, though are smaller and only significant for two‐ and three‐year horizons once stocks trading OTC are excluded. Thus, their results are largely consistent with the earlier findings of Eberhart, Altman, and Aggarwal (1999).
While the results of these studies are clearly of interest to potential investors, the implications for evaluating Chapter 11 are less clear. Direct comparison with studies of operating performance are difficult because of sample selection issues, with only some firms emerging with publicly traded stock. Regardless, in contrast to studies showing poor operating performance, the stock performance indicates that firms do better than the market had expected at the time of emergence. These results may also be related to management incentives to issue relatively low firm valuations as part of the plan confirmation process.
Early critics of the Chapter 11 process have primarily argued that the current U.S. bankruptcy system is biased toward allowing inefficient firms to reorganize. These critics have focused either on specific provisions of the Bankruptcy Code, which are characterized as “prodebtor” (such as management's ability to remain in control and initially propose a plan of reorganization), or on the behavior of particular courts which have been characterized as too prodebtor. More recently, the balance of power is argued to have swung in the direction of senior creditors (see Chapter 6 herein).
The high incidence of failures subsequent to leaving Chapter 11, which has been described in detail in this chapter, is certainly consistent with the view of excessive continuation. However, it is also clear that the governance structure of the emerging firm is importantly related to postbankruptcy performance; as more firms exit Chapter 11 under the control of senior creditors, the problem of recidivism may decline. The fact that Chapter 22s have continued even recently still suggests, however, that a number of firms emerging from bankruptcy continue to be overlevered or have poor operating prospects.