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Bargaining around Bankruptcy: Small Business Workouts and State Law

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  • Edward R. Morrison

Abstract

Federal bankruptcy law is rarely used by distressed small businesses. For every 100 that suspend operations, at most 20 file for bankruptcy. The rest use state law procedures to liquidate or reorganize. This paper documents the importance of these procedures and the conditions under which they are chosen using firm-level data on Chicago-area small businesses. I show that business owners bargain with senior lenders over the resolution of financial distress. Federal bankruptcy law is invoked only when bargaining fails. This tends to occur when there is more than one senior lender or when the debtor has defaulted on senior debt (harming trust-based relationships with lenders). These findings raise questions about the design of and need for federal bankruptcy law. (c) 2009 by The University of Chicago. All rights reserved.

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  • Edward R. Morrison, 2009. "Bargaining around Bankruptcy: Small Business Workouts and State Law," The Journal of Legal Studies, University of Chicago Press, vol. 38(2), pages 255-307, June.
    • Handle: RePEc:ucp:jlstud:v:38:y:2009:i:2:p:255-307
    DOI: 10.1086/597982
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    Cited by:

    1. Miguel García-Posada & Juan Mora-Sanguinetti, 2014. "Are there alternatives to bankruptcy? A study of small business distress in Spain," SERIEs: Journal of the Spanish Economic Association, Springer;Spanish Economic Association, vol. 5(2), pages 287-332, August.
    2. Blanco, Roberto & Fernández-Ortiz, Elena & García-Posada, Miguel & Mayordomo, Sergio, 2024. "A new estimation of default probabilities based on non-performing loans," Finance Research Letters, Elsevier, vol. 62(PB).
    3. Rachid Achbah, 2024. "Manager Characteristics and SMEs' Restructuring Decisions: In-Court vs. Out-of-Court Restructuring," Papers 2402.18135, arXiv.org.
    4. Silva, Mario Rafael, 2019. "Corporate finance, monetary policy, and aggregate demand," Journal of Economic Dynamics and Control, Elsevier, vol. 102(C), pages 1-28.
    5. Ewelina Mruk & Inmaculada Aguiar-Díaz & Maria Victoria Ruiz-Mallorquí, 2019. "Use of formal insolvency procedure and judicial efficiency in Spain," European Journal of Law and Economics, Springer, vol. 47(3), pages 435-470, June.
    6. Rachid Achbah, 2023. "Manager Characteristics and SMEs’ Restructuring Decisions: In-Court vs. Out-of-Court Restructuring," Post-Print hal-04279942, HAL.
    7. Nicolae Stef, 2023. "Bankruptcy voting process and corporate reorganization," Bulletin of Economic Research, Wiley Blackwell, vol. 75(2), pages 508-524, April.
    8. Michael Minnis & Andrew Sutherland, 2017. "Financial Statements as Monitoring Mechanisms: Evidence from Small Commercial Loans," Journal of Accounting Research, Wiley Blackwell, vol. 55(1), pages 197-233, March.
    9. Marco Celentani & Miguel García-Posada & Fernando Gómez Pomar, 2022. "Fresh start policies and small business activity: evidence from a natural experiment," Working Papers 2210, Banco de España.
    10. Nuri Ersahin & Rustom M. Irani & Katherine Waldock, 2016. "Creditor Rights and Entrepreneurship: Evidence from Fraudulent Transfer Law," Working Papers 16-31, Center for Economic Studies, U.S. Census Bureau.
    11. Zacharias Sautner & Vladimir Vladimirov, 2018. "Indirect Costs of Financial Distress and Bankruptcy Law: Evidence from Trade Credit and Sales [Bankruptcy codes and innovations]," Review of Finance, European Finance Association, vol. 22(5), pages 1667-1704.

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