DP3481 Control Benefits and CEO Discipline in Automatic Bankruptcy Auctions

Author(s): B Espen Eckbo, Karin S Thorburn
Publication Date: July 2002
Keyword(s): bankruptcy, CEO turnover, executive compensation, post-bankruptcy performance, private benefits of control, risk-shifting incentives
JEL(s): D44, G33, G34, K22
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=3481

We argue that the existence of CEO private control benefits complements managerial reputation in counteracting costly shareholder risk-shifting incentives during severe financial distress, when job-loss may be imminent. We examine this argument empirically using bankruptcy filings in Sweden, where a filing automatically terminates CEO employment and requires the firm to be sold in an open auction. The median CEO income loss is a dramatic 40%, suggesting that bankruptcy filing damages CEO reputation. Empirical proxies for both CEO reputation and control benefits are significant determinants of the probability of the CEO being rehired by the buyer in the auction, as predicted. Moreover, we find that the rehired CEOs generate a post-bankruptcy accounting performance at par with industry rivals. The surprisingly strong survival characteristics of the reorganized firms are consistent with managerial conservatism ex ante, and help alleviate creditor concern with costly asset substitution designed to delay filing in an automatic bankruptcy auction system.