Bankruptcy as a Legal Process

Abstract

In this paper we empirically assess bankruptcy as a legal process. We examine a comprehensive reform to corporate bankruptcy law in Mexico, which streamlined the legal process and limits on litigation. Then we outline the ways in which bankruptcy law design affect a series of outcome variables. Using a hand-coded data set from court dockets, we measure procedural speed, recovery rates of creditors' claims, and violations to the absolute priority rule (APR); we also track and compare litigation throughout the bankruptcy process. Our investigation of the reform finds: (1) a decrease in the average time spent in bankruptcy from 7.8 to 2.3 years; (2) an increase in average recovery rates from 19 to 32 cents on the dollar; and (3) a decrease in the frequency of APR violations from 29 to 2 percent. Structural and administrative changes explain about 50 percent of the improvement in our outcomes variables, while changes in the regulation of the process, particularly on the ability to litigate, explain the remaining portion. More precisely, strategic litigation is strongly associated with lower recovery rates and longer procedural times. The results are not driven by censoring bias and are robust to time, firm, and court-specific considerations. Our findings suggest bankruptcy law reform should be focused on simplifying the legal process, introducing statutory timelines, and restricting litigation.

Keywords: corporate bankruptcy, liquidation, litigation

JEL Classification: G33, G34