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To: on parole who wrote (53545)	7/5/2000 12:52:07 PM
From: on parole	Read Replies (1) \| Respond to of 150070

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%.