Market Reaction to Announcements of Debtor-in-Possession Financing: An Empirical Investigation of Bankruptcy Outcome, Duration and Loan Characteristics
Posted: 22 Feb 1999
Date Written: January 1999
Abstract
This paper examines the market reaction to the announcement of Debtor-in-Possession (DIP) loan agreements on the market value of equity of DIP borrowers. It studies the relation between DIP financing and the probability of successful reorganization, the length of time spent under Chapter 11 bankruptcy, and infers the effect on total bankruptcy costs. The results show that market price reaction to the announcement of DIP financing is positive and statistically significant. This result is consistent with a market perception that the DIP announcement sends a positive signal that borrowers face a relatively low probability of liquidation and are more likely to emerge successfully from bankruptcy. It is proposed that logically bankruptcy costs are expected to be positively related to length of time spent under Chapter 11. If so, a positive relation between DIP financing and successful emergence may be extended to propose that firms which obtain DIP loans and successfully emerge from Chapter 11 will have lower bankruptcy costs than firms which do not obtain DIP loans.
The results show a direct relation between obtaining DIP financing and an increased probability of recovering from Chapter 11, and lower bankruptcy duration. However, it is undoubtedly true that lenders to some extent tend to lend to firms with a lower probability of liquidation in the first place. The results also show that DIP announcements generate greater equity returns for the borrowers when the loans come from existing (versus new) lenders and from banks (and opposed to non-banks). Finally DIP announcements appear to have an information impact as equity returns to DIP borrowers are more positive when the DIP loan is the initial post-petition announcement (versus a subsequent loan announcement) and the loan is relatively large compared to pre-bankruptcy total assets.
JEL Classification: G32, G3, G2, G21
Suggested Citation: Suggested Citation