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5 Rev. L & Econ. 1 (2009)

handle is hein.journals/rvleco5 and id is 1 raw text is: Macroeconomic Instability and Corporate Failure: The Role of the Legal System* ARNAB BHATTACHARJEE,t CHRISTOPHER HIGSON,tt SEAN HOLLY,± PAUL KATTUMAN± I University of St. Andrews; London Business School; IUniversity of Cambridge We examine how macroeconomic instabiliy affects rsk of bankrupty and liquidation. In pedods of macroeconomic instabiliy more firms become financialy distressed, while the number of potential acquirers falls. ReorganiZation systems such as Chapter 11 can decouple liquidation from macroeconomic conditions. We develop a model in which a firm's bankrupty and acquisition hazards are co-determined by firm-level and sector-level factors, and by macroeconomic conditions. As a control, we also estimate the modelfor the UK, which is an economy without an equivalent system to Chapter 11. Dfferences in the responsiveness of bank ruptg to instabiliy are largely attributable to reorganization under Chapter 11. 1. INTRODUCTION This paper examines how macroeconomic instability affects a firm's risk of bankruptcy and liquidation. Reviewing the literature, Caves (1998) concludes that US bankruptcy hazard rates are rather insensitive to variation in the macro environment. This is a puzzling result, as the number of failing firms is likely to increase when there is a macroeconomic downturn. For some of these firms, being bought is an alternative to being liquidated, but merger activity is strongly pro-cyclical, so that there are fewer acquirers around just when they are needed. As a consequence of these two effects, we might expect the economy to experience a sharp increase in liquidations in periods of macroeconomic instability. However, a missing element in this story is the role of the legal system. One effect of a reorganization system such as US Chapter 11 can be to decouple liquidation from macroeconomic conditions by providing a place where failing firms can shelter and, in some cases, wait for acquisition markets to become active again.'

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