Bankrupcy conclusion
V. CONCLUSION
This paper has examined firms whose shares continued to be actively
traded after filing for bankruptcy to determine if the stock price reflected
what the shareholders would ultimately receive. We showed that, in
retrospect, investors grossly overpaid for what would be received from
bankrupt companies. About a quarter of the firms filed reorganization
plans which gave nothing to the shareholders. Although none of these
firms ultimately gave anything to the shareholders, the stock of roughly
one-third of these companies continued to be actively traded after the
plans were filed, at prices that appear to be irrational.
Over one-third of the entire sample was delisted before ever filing a
reorganization plan. For those remaining on an exchange, the price the
day after the first plan was filed was, on average, well above what the
shareholders ultimately received. For example, the mean return from the
filing of the first plan to the date a plan was confirmed by the bankruptcy
court was -22%, with a median loss of -48%. This occurred during a
period of substantial appreciation in the overall stock market.
One implication of this research is that investors do not appear to
understand the bankruptcy process and/or are not aware of the terms of
publicly available reorganization plans. Given that corporate insiders and
institutional investors do understand the reorganization process, perhaps
the regulations surrounding the trading of bankrupt stocks should be
reevaluated.
Acknowledgment: We wish to thank Chris Loudon for his valuable
research assistance and Middlebury College for financial assistance. We
also thank two anonymous reviewers for their helpful comments.
NOTES
* Direct all correspondence to: Levin Stephenson, Middlebury College,
Department of Economics, Middlebury, VT 05753.
1. For example, Brealey and Myers (1988) claim unsecured creditors
receive on average only about eight percent of their claim in liquidations.
Of 25 firms examined by Morse and Shaw (1988) which initially filed to
reorganize but were ultimately liquidated, shareholders of all but one firm
received nothing.
2. For example, Stephenson (1993) examined 72 bankruptcies and found
that the approved reorganization plan was sponsored or co-sponsored by
management in 93% of the bankruptcies. Combining their data, Weiss
(1990) and Frank and Torous (1989) found absolute priority violations in
41 of 55 reorganizations.
3. This list was compiled from The Bankruptcy Yearbook (1991-1994),
Predicast's F&S Index to Corporate Change, The Capital Change
Reporter, and Stocks and Bonds on the New York Stock Exchange.
4. In a pre-packaged bankruptcy, the firm negotiates with creditors
before filing for bankruptcy. A reorganization plan is typically filed with
the Chapter 11 bankruptcy, and the firm will usually emerge from
bankruptcy in one to three months.
5. For some of the firms filing bankruptcy before 1990 that were no
longer in existence, details of the reorganization plan were gathered from
various files within Lexis/Nexis or from SEC filings.
6. The day after Continental closed at $1.50, an article appearing on the
front page of the financial section of The New York Times titled
"$1.50-a-Share Price for Worthless Stock on Major Exchange" detailed
the plight of Continental's stock and claimed the stock "...is officially
worthless. Even the company says so." Continental's stock fell 58% to
close at $0.625 per share and was delisted two days later. Over seven
million shares traded hands in the final three days of trading.
7. Many on Wall Street apparently believe investors do not realize the
company is bankrupt or do not understand the bankruptcy process.
Comments include "They clearly didn't understand that what they had
been sold was the old common stock, which was about to be wiped out,
as opposed to the new common, which had true value" (Dorfman, 1993)
and "Investors, particularly retail customers, often misunderstand these
terms, buying the almost worthless shares at increasing prices on the
belief that they are investing in a corporate turnaround" (Halkias, 1993).
Some investors may have purchased stock in bankrupt firms as part of a
broader investment strategy, For example, the bankrupt stock might have
been only one piece of a hedge position. An anonymous referee relayed
the tale of John Marks Templeton, upon hearing of the outbreak of
World War II, instructed his broker to purchase shares in NYSE
companies priced below a dollar, including bankrupt companies.
Templeton correctly believed that war in Europe would be good for U.S.
business, and the biggest percentage gainers would be those in the very
worst shape.
8. For example, recall Wang Laboratories gave its shareholders only
warrants, which it valued at a few cents per share. After its stock closed
at $1.00, the company issued a statement warning of a "discrepancy"
between recent trading prices and the anticipated low value when the
company expected to emerge from bankruptcy in two months. After its
stock closed at $0.625, Wang issued a statement saying "These warrants
will trade - we are really being literal here - for a few pennies, I am not
saying a dime or a nickel; I'm saying a few pennies" (Zitner, 1993).
9. The closing price the day after the plan was filed or confirmed is used
since the announcement might occur after the market closed. One week
after the effective date is used because in some cases the new securities
did not begin trading until a few days after the effective date.
10. Note that this assumes a beta of one for each company (which is
unrealistic for bankrupt companies) and that market-adjusted returns are
not bounded by -100%.
11. If returns are calculated using the last available price during the
bankruptcy (the delisting price or the effective date price), the mean raw
return to one week after the effective date, which we report in Table 2 as
-38%, changes to -34%. |
