Winston Wei Dou

Dissecting Bankruptcy Frictions

Joint with Lucian Taylor, Wei Wang, Wenyu Wang

Journal of Financial Economics Revise and Resubmit, July 2020

How efficient is corporate bankruptcy in the U.S.? Two economic frictions, asymmetric information and conflicts of interest among creditors, can cause several inefficiencies: excess liquidation, excess continuation, and excess delay. We quantify these inefficiencies and their underlying causes using a structural estimation approach. We find that the bankruptcy process is quite inefficient, mainly due to excess delay. Eliminating information asymmetries would increase average total payouts by 4%, and eliminating conflicts of interest would increase them by an additional 18%. Without these frictions, an extra 14% of cases would be resolved before going to court, and the remaining court cases would be 73% shorter. With less delay, bankruptcy’s indirect costs would be much lower. In contrast, we find that inefficiencies from excess liquidation and excess continuation are quite small.