Bad news does not always travel fast: evidence from Chapter 11 bankruptcy filings

Abstract

This paper examines the stock price performances of 275 non-financial, nonutility U.S. industrial firms that continue trading on the main exchanges after filing for Chapter 11 bankruptcy between 1 October 1979 and 17 October 2005. This paper identifies a negative and statistically significant post-bankruptcy drift that lasts for at least 6 months. This finding adds to the literature showing that the market is unable to process bad public news events in a timely manner. Further analysis suggests that the theoretical model proposed by Hong and Stein (1999) can be used to help explain this market-pricing anomaly. 4 See Hotchkiss et al. (2008) for a recent survey of this literature. © 2013 AFAANZ 416 L. M. S. Coelho/Accounting and Finance 55 (2015) 415-442 5 Lee and Swaminathan (2000), however, show that trading volume enhances (or weakens) price momentum in loser (or winner) stocks. As the authors point out, their findings are inconsistent with the predictions of the HS model, conditional on whether trading volume is a good proxy for information diffusion. © 2013 AFAANZ L. M. S. Coelho/Accounting and Finance 55 (2015) 415-442 © 2013 AFAANZ L. M. S. Coelho/Accounting and Finance 55 (2015) 415-442 419 11Controlling for risk is always challenging in medium-term event studies (Kothari and Warner, 2007). Subsection 3.2 presents additional results based on alternative benchmark samples that control for size and earnings surprises, size, and momentum, and industry, size, and the book-to-market ratio.

Saddled with Attention: Overreaction to Bankruptcy Filings

“…The common stocks of many companies continue trading after a bankruptcy filing. Dawkins et al (2007), Branch and Xu (2013), Coelho (2013), and Li and Zhong (2013) find evidence of large losses arising from holding stock before and during bankruptcy filings. However, the relationship between performance and attention has not been previously analyzed in depth.…”

“…They also find that steeper falls on the filing date lead to more significant reversals immediately afterward, which suggests an overreaction during the filing period. Coelho (2013) conducts a longer-horizon study and finds that the market is unable to process bankruptcy filing news in a timely manner. He analyzes the stock performance of 275 Chapter 11 cases between 1979 and 2005 and finds evidence consistent with Dawkins et al (2007).…”

“…where r i, t is the actual return for firm i on day t and r b i,t corresponds to its benchmark return on that same day. 17 We follow previous studies and compute ARs relative to the market return, since it is common to use this benchmark during bankruptcy periods (Dawkins et al 2007;Coelho 2013;Li and Zhong 2013). 18 The full list of variable definitions and data sources is available in Table 1.…”

“…Coelho () leaves out utilities and financial companies from his study, because bankruptcy law applies differently to the former and the latter are heavily regulated. There are 12 such companies in our sample.…”

“…However, in a sample of Chapter 11 filings between 1979 and 2005, Coelho () finds a positive average abnormal return in the [2, 5] window. This is evidence of a mild overreaction on the filing date, which reverses the week after.…”