By Benjamin Iverson, Kellogg School of Management at Northwestern University
On average, total bankruptcy filings rise by 32% during economic recessions, leaving bankruptcy judges with far less time per case exactly when financial distress is worst. The inflexible nature of the bankruptcy system coupled with the varying demands placed upon it, leads to the concern that time constraints might limit the effectiveness of bankruptcy when economic conditions deteriorate.
In my paper, “Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts,” I test whether Chapter 11 restructuring outcomes are affected by time constraints in busy bankruptcy courts. Using the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005 as a shock that decreased caseloads dramatically, I show that as bankruptcy judges become busier they tend to allow more firms to reorganize and liquidate fewer firms. I interpret this as evidence that busy bankruptcy judges defer to the debtor in possession more often, scrutinizing each case less and thereby allowing reorganization more often. In addition, I find that firms that reorganize in busy courts tend to spend longer in bankruptcy, while firms that are dismissed from busy courts are more likely to re-file for bankruptcy within three years of their original filing.
Perhaps most striking, I also show that busy courts impose costs on local banks, which report higher charge-offs on business lending when caseload increases. If time constraints create higher costs of financial distress, it appears that these costs are typically passed on to the creditors of the bankrupt firms in the form of higher losses on distressed loans.
The full-length article can be found here.