Control Benefits and CEO Discipline in Automatic Bankruptcy Auctions

Abstract

Swedish bankruptcy filing automatically terminates CEO employment and triggers an auction of the firm. Critics of this system warn of excessive shareholder risk-shifting incentives prior to filing. We argue that private benefits of control induce managerial conservatism that may override risk-shifting incentives. By investing conservatively, the CEO increases the joint probability that the auction results in a going-concern sale and that she is rehired. This uniquely implies that the rehiring probability is increasing in private control benefits, which our empirical results support. We also find that buyers in the auction screen on CEO quality. Overall, labor market discipline is dramatic, as filing CEOs suffer large income losses relative to CEOs of matched, non-bankrupt firms. Firms emerging from bankruptcy typically perform at par with industry rivals.

Keywords: CEO Turnover, Executive Compensation, Private Benefits of Control, Risk-shifting Incentives, Bankruptcy, Post-bankruptcy Performance

JEL Classification: D44, G33, G34, K22