Essays in Bankruptcy and Financial Distress

This dissertation is the final product of my PhD studies at the Department of Finance at Copenhagen Business School. The thesis consists of three chapters, which study how the bankruptcy institution—bankruptcy law and bankruptcy judges—affects the ex-post resolution of financial distress. The chapters are self-contained and can be read independently.
In the first chapter, “Wealth Protection in Bankruptcy and Serial Entrepreneurship,” I study whether wealth protection in personal bankruptcy provides a second chance to failed entrepreneurs. I exploit windfall wealth from inheritances to proxy for exogenous variation in personal wealth after bankruptcy. Windfall wealth increases reentry to business only among entrepreneurs who did not experience severe losses in personal income or wealth before bankruptcy. Those who respond to windfall wealth by starting new businesses have lower profits, indicating their lower entrepreneurial quality. Overall, the findings suggest that bankruptcy policies increasing wealth protection can promote serial entrepreneurship, but their effectiveness is limited by low entrepreneurial quality and personal experience of severe losses.
In the second chapter, “Biased Judges? Judge Characteristics and Bankruptcy Outcomes,” exploiting the random assignment of judges to corporate bankruptcy filings, I examine the effect of judge characteristics on outcomes. First, I find that cases assigned to judges who grew up during the Great Depression are more likely to emerge from bankruptcy, whereas those assigned to judges with economics training and conservative political ideology are more likely to result in liquidation. Second, I show that the case duration is shorter (longer) when the potential case outcome is consistent (inconsistent) with judges’ preferences. Third, the judge characteristics do not correlate with post-emergence outcomes. Overall, the findings suggest that the effect of judge characteristics may be concentrated in marginal cases where the economic benefits of liquidation versus emergence are not significantly different.
In the third chapter, “Disqualifying Managerial Misconduct in Corporate Bankruptcy” (with S. Lakshmi Naaraayanan and Kasper Meisner Nielsen) we examine the introduction of bankruptcy quarantines that disqualifies managers engaging in negligent business practices for up to 3 years. Using administrative register data from Denmark, we document that disqualifications discourage future business activity: after the quarantine, individuals are 15% less likely to be managers or business owners. Disqualified individuals are also less likely to be involved in future bankruptcies or future criminal activities. At the same time, the fraction of family members of disqualified individuals who are active in a management role increases from 10% to 30%. We also find changes to the managerial labor pool, resulting in more CEOs with a criminal record and those relying solely on social transfers. Overall, our findings provide the first systematic evidence on the governance consequences of disqualifying managerial misconduct in corporate bankruptcies.