DP5035 A Study of Inefficient Going Concerns in Bankruptcy

Author(s): Julian R Franks, Gyöngyi Lóránth
Publication Date: May 2005
Keyword(s): Allocation of Control Rights, Bankruptcy Code, Compensation, Recovery Rates
JEL(s): G21, G30, G33
Programme Areas: Financial Economics, Institutions and Economic Performance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5035

This paper provides the first large-scale study measuring the bias in favour of going concerns induced by court-administered bankruptcy procedures. Although we find that the large majority of bankrupt firms in our sample of Hungarian firms are kept as going concerns, the evidence suggests that the going concern bias sharply reduces aggregate proceeds to pre-bankruptcy creditors. The high costs are accompanied by the eventual closure and piecemeal sale of three quarters of going concerns. These results arise because of poor court oversight and the compensation scheme awarded to the court appointed trustee managing the bankrupt company. Comparisons with other bankruptcy codes suggest that the application of the code and court procedures have an important impact on outcomes, including the degree of inefficiency.