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Forced conversion to Chapter 7 bankruptcy and optimal financial decisions

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  • Kim, Hwa-Sung

Abstract

Empirical studies show that quite a few firms that initially filed for Chapter 11 were converted to Chapter 7 by bankruptcy judges, and that the conversion rate differs across judges. This study examines a firm’s optimal financial decisions when it is exposed to forced conversion. We find that forced conversion decreases shareholders’ incentives to invest and reduces the optimal leverage ratio. We show that equity risk after filing for Chapter 11 is more sensitive to forced conversion. When shareholders anticipate that forced conversion is more likely, the investment option value can be lower due to their opportunistic behavior.

Suggested Citation

  • Kim, Hwa-Sung, 2023. "Forced conversion to Chapter 7 bankruptcy and optimal financial decisions," Finance Research Letters, Elsevier, vol. 54(C).
    • Handle: RePEc:eee:finlet:v:54:y:2023:i:c:s1544612323000910
    DOI: 10.1016/j.frl.2023.103717
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    References listed on IDEAS

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    More about this item

    Keywords

    Bankruptcy judges; Chapter 7 liquidation; Chapter 11 reorganization; Optimal financial decisions;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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