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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