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We develop a model of a firm in financial distress. Distress can be mitigated by filing for bankruptcy, which is costly, or preempted by restructuring, which is impeded by a collective action problem. We find that bankruptcy and restructuring are complements, not substitutes: Reducing bankruptcy costs facilitates restructuring, rather than crowding it out. And so does making bankruptcy more debtor-friendly, under a condition that seems likely to hold now in the United States. The model gives new perspectives on current relief policies (e.g., subsidized loans to firms in bankruptcy) and on long-standing legal debates (e.g., the efficiency of the absolute priority rule).

Policymakers have minimized the role of bankruptcy law in mitigating the financial fallout from COVID-19. Scholars too are unsure about the merits of bankruptcy, especially Chapter 11, in resolving business distress. We argue that Chapter 11 complements current stimulus policies for large corporations, such as the airlines, and that Treasury should consider making it a precondition for receiving government-backed financing. Chapter 11 offers a flexible, speedy, and crisis-tested tool for preserving businesses, financing them with government funds (if necessary), and ensuring that the costs of distress are borne primarily by investors, not taxpayers. Chapter 11 saves businesses and employment, not shareholders. For consumers and small businesses, however, bankruptcy should serve as a backstop to other policies, such as the CARES Act. Consumer bankruptcy law’s primary goal is to discharge debts, but that’s not what most consumers need right now. What they need is bridge financing, and perhaps forbearance, until the crisis ends, they get back to work, and they regain their ability to pay their debts again. These key policy levers—bridge financing and forbearance—are available in theory to small businesses in Chapter 11, especially if the government supplies the bridge financing when credit markets are dysfunctional. The practical reality is that bankruptcy is expensive for small businesses, which may deter them from using it in the first place. Equally important, our courts will be flooded if Chapter 11 is the primary rescue policy for small businesses.

Background: Alcohol intoxication has been associated with increases in risk taking behavior and more ambiguously, alterations in emotional perception. In the first study of its kind, we examine how theories of disgust can be used to help explain these effects.Methods: Using a single-blind procedure, participants (n=73) were randomly allocated to an alcohol (Males: 0.68g/kg; Females: 0.60g/kg) or placebo condition and then completed a psychometric measure of disgust (TDDS).Results: Results revealed a non-significant trend toward lower disgust sensitivity in the alcohol versus placebo condition. We did however find a significant negative correlation, whereby increases in breath alcohol level were associated with decreased pathogen disgust.Conclusions: These findings demonstrate a relationship between breath alcohol level and disgust sensitivity which could help explain differences in risk associated behavior.

Sex hormones are thought to influence human mate preferences. Previous studies have reported mixed results regarding the association between men’s testosterone levels and their mate preferences. The present study investigated the effect of testosterone administration on men’s facial femininity preference. Heterosexual Chinese male participants (n = 140) received a single dose of 150 mg testosterone or placebo gel in a double-blind, placebo-controlled, between-participant design. Results showed that Chinese men demonstrated general preferences for feminized women’s faces, consistent with previous results from the Western population. More importantly, men showed stronger attraction to femininity in women’s faces three hours after testosterone administration than at the beginning of the session. In the placebo group, no significant change in facial femininity preferences was found between time points. These results indicate that exogenous testosterone increases men’s facial femininity preferences in a Chinese population.

Random case assignment is thought to be an important feature of decision-making in federal courts because it helps guard against favoritism (actual or perceived) toward particular parties or types of cases. In bankruptcy courts, cases are randomly assigned to both judges and trustees. In Chapter 7 cases, for example, the trustee is a quasi-judicial actor, typically a private-sector lawyer, who has been selected to audit the debtor's finances, find and liquidate assets, and police compliance with the law. We study three major bankruptcy jurisdictions (covering Chicago, Los Angeles, and parts of New York) and find that the random-assignment process for Chapter 7 trustees is failing in two of them (Chicago and New York). We introduce several measures of non-random assignment. Across all measures, random assignment is failing: Trustees within the same court have substantially different case characteristics, despite the purportedly random assignment process. We present evidence that the imbalance in case characteristics is caused by attorney manipulation: Attorneys strategically time their case filings to avoid or attract particular trustees ("trustee shopping"). By contrast, among cases filed by debtors who have not hired attorneys ("pro se filers"), there is no case imbalance across trustees. Because they do not engage in manipulation, pro se filers – who account for the bottom decile of income and asset values among Chapter 7 debtors – are the debtors most burdened by trustee-shopping by bankruptcy attorneys. We conclude by presenting evidence that trustee-shopping is less prevalent in Los Angeles due to differences in its random-assignment protocol.

African American bankruptcy filers are more likely to select Chapter 13 than other debtors, who opt instead for Chapter 7, which has higher success rates and lower attorney fees. Prior scholarship blames racial discrimination by bankruptcy attorneys. We present an alternative explanation: Chapter 13 offers benefits, including retention of assets such as cars and driver's licenses, that are more valuable to African American debtors because they have relatively long commutes. We take advantage of a 2011 policy in Chicago, which suspended driver's licenses of consumers with large traffic-related debts. The policy produced a large increase in Chapter 13 filings, especially by African Americans. Two mechanisms explain the disparate racial impact: African Americans were more likely to have traffic-related debts and they incurred greater costs from license suspension due to their relatively long commutes. When we match African Americans to other debtors with similar commutes, we find no racial difference in the propensity to file for Chapter 13. These findings suggest that racial disparities in bankruptcy reflect racial disparities in commuting.

In the United States, few failing businesses invoke the Bankruptcy Code to reorganize or liquidate. Most use non-bankruptcy procedures to accomplish the same purposes. These procedures include voluntary agreements between the debtor and its creditors (workouts) and formal devices such as friendly foreclosures, bulk sales, and assignments for the benefit of creditors. This paper documents the importance of non-bankruptcy procedures using firm-level data from Cook County, Illinois. I find that these procedures are used by eighty percent of distressed small businesses. The paper also identifies the conditions under which a business chooses federal bankruptcy law over non-bankruptcy procedures. I model this choice - theoretically and empirically - as the outcome of a bargaining game between the debtor's owner and its senior lenders. The parties are more likely to consent to non-bankruptcy procedures when bargaining costs are low and when the debtor has maintained a close relationship with senior lenders, who trust the information provided by the owner. When the number of senior lenders is relatively large (raising bargaining costs) or when the debtor has defaulted on senior debt (thereby harming its relationship with lenders), senior lenders are more likely to push for a federal bankruptcy filing. Owners may also prefer a federal filing when in-bankruptcy rules give greater priority to particular creditors whom the owner would like to favor. These findings suggest that federal bankruptcy reforms, such as the Bankruptcy Abuse and Protection Act of 2005, will have two effects on distressed small businesses: They will impact outcomes in federal courts (intensive margin) as well as the debtor's choice between bankruptcy and non-bankruptcy procedures (extensive margin). Variation along the extensive margin can neutralize reforms in federal law, as when a reform designed to protect unsecured creditors raises the cost of federal law and induces businesses to use cheaper non-bankruptcy procedures instead.

Many small businesses attempt to reorganize under Chapter 11 of the U.S. Bankruptcy Code, but most are ultimately liquidated instead. Little is known about this shutdown decision. It is widely suspected that the bankruptcy process exhibits a continuation bias, allowing failing businesses to linger under the protection of the court, which resists liquidation even when it is optimal. This paper examines the shutdown decision in a sample of Chapter 11 bankruptcy cases filed in a typical bankruptcy court over the course of a year. The presence of continuation bias is tested along several dimensions—the extent of managerial control over the bankruptcy process, the accuracy and speed with which viable and nonviable businesses are distinguished, and the characteristics of the hazard of shutdown compared with the predictions of a formal model. Contrary to conventional wisdom, the paper finds that continuation bias is either absent or empirically unimportant.

This paper explores the role of capital structure in determining how households respond to unanticipated shocks. We draw on a novel dataset linking individual cancer records to high-quality administrative data on personal mortgages, bankruptcies, foreclosures, and credit reports. We find that cancer diagnoses induce a substantial increase in various measures of financial stress regardless of whether the patient carries health insurance. Foreclosure rates, for example, increase 65 percent during the five years following diagnosis. The effect, however, is concentrated among patients with low levels of housing equity. Highly leveraged households default, undergo foreclosure, or file for bankruptcy; less-levered households cope with health shocks by drawing on home equity and other sources of liquidity. These results point to the critical role of capital structure in determining how households respond to severe shocks. They also suggest that household leverage may merit as much policy attention as health insurance.

When a firm encounters financial distress, there is a significant possibility that, at some point, the firm itself should be shut down and its assets put to better use. But Chapter 11 and indeed all market-mimicking reorganization regimes other than a speedy auction entrust the shutdown decision to a bankruptcy judge who lacks information and expertise, as well as the ability to control the timing of her decisions. Understanding the costs of entrusting the shutdown decision to a bankruptcy judge is central to assessing any law of corporate reorganizations. This article models the shutdown decision as the exercise of a real option. The model suggests that the shutdown decision may loom so large in the early parts of the bankruptcy case that it erases any significant difference between Chapter 11 and many alternative market-mimicking regimes. All these regimes take more time than mandatory auctions and thus increase the cost of taking the shutdown decision away from a market actor. Moreover, the real option itself gives parties an incentive to withhold information. Only a system of mandatory auctions both limits the amount of time the shutdown option resides with an inexpert decision maker and forces insiders to give that decision maker sufficient information to value the option

This paper assesses the importance of adverse health shocks as triggers of bankruptcy filings. We view car crashes as a proxy for health shocks and draw on a large sample of police crash reports linked to hospital admission records and bankruptcy case files. We report two findings: (i) there is a strong positive correlation between an individual's pre-shock financial condition and his or her likelihood of suffering a health shock, an example of behavioral consistency; and (ii) after accounting for this simultaneity, we are unable to identify a causal effect of health shocks on bankruptcy filing rates. These findings emphasize the importance of risk heterogeneity in determining financial fragility, raise questions about prior studies of "medical bankruptcy," and point to important challenges in identifying the triggers of consumer bankruptcy.

We investigate whether homeowners respond strategically to news of mortgage modification programs by defaulting on their mortgages. We exploit plausibly exogenous variation in modification policy induced by U.S. state government lawsuits against Countrywide Financial Corporation, which agreed to offer modifications to seriously delinquent borrowers with mortgages throughout the country. Using a difference-in-difference framework, we find that Countrywide's relative delinquency rate increased more than ten percent per month immediately after the program's announcement. The borrowers whose estimated default rates increased the most in response to the program were those who appear to have been the least likely to default otherwise, including those with substantial liquidity available through credit cards and relatively low combined loan-to-value ratios. These results suggest that strategic behavior of borrowers should be an important consideration in designing mortgage modification programs.

General Motors (GM) has broken a record. The Big-Three automaker posted a phenomenal $23.5 billion loss for fiscal year 1992 (White, 1993, p. A3). Paradoxically, this world-record loss accompanied reports that GM generated income of $92 million from operations in 1992 (Dubrowski, 1993). The accounting data seem contradictory: How could GM incur a record loss when its operations are improving? The answer: GM recorded a “one-time hit.” Company executives recognized the cumulative effect of previously undisclosed liabilities for postretirement benefits -namely, a $20.8 billion obligation for retiree medical benefits. Prior to issuance of GM’s 1992 financial statements, these liabilities were off-balance sheet. That is, they existed outside the realm of financial reporting. GM is not alone. Many companies maintain off-balance sheet assets and liabilities. This essay explores some of the critical issues surrounding off-balance sheet risks (O&S&), namely, (1) the nature of OBSR, (2) managerial motivation to pursue off-balance sheet activities, (3) the importance of disclosing these activities, and (4) the Financial Accounting Standards Board (FASB) crusade to control OBSR.

Most nations have enacted statutes governing business liquidation and reorganization. These statutes are the primary focus when policymakers and scholars discuss ways to improve laws governing business failure. This focus is misplaced, at least for distressed small businesses in the United States. Evidence from a major credit bureau shows that over eighty percent of these businesses liquidate or reorganize without invoking the formal Bankruptcy Code. The businesses instead invoke procedures derived from the laws of contracts, secured lending, and trusts. These procedures can be cheaper and speedier than a formal bankruptcy filing, but they typically require unanimous consent of senior, secured lenders. This essay identifies the conditions under which a business owner is able to obtain lender consent. The empirical findings point to an important balance between a nation's formal insolvency statutes and alternative modes of liquidation and reorganization. This balance, the essay argues, should play a central role in any discussion of insolvency-law reform.

We analyze a sample of large privately and publicly held businesses that filed Chapter 11 bankruptcy petitions during 2001. We find pervasive creditor control. In contrast to traditional views of Chapter 11, equity holders and managers exercise little or no leverage during the reorganization process. 70 percent of CEOs are replaced in the two years before a bankruptcy filing, and few reorganization plans (at most 12 percent) deviate from the absolute priority rule to distribute value to equity holders. Senior lenders exercise significant control through stringent covenants, such as line-item budgets, in loans extended to firms in bankruptcy. Unsecured creditors gain leverage through objections and other court motions. We also find that bargaining between secured and unsecured creditors can distort the reorganization process. A Chapter 11 case is significantly more likely to result in a sale if secured lenders are oversecured, consistent with a secured creditor-driven fire-sale bias. A sale is much less likely when these lenders are undersecured or when the firm has no secured debt at all. Our results suggest that the advent of creditor control has not eliminated the fundamental inefficiency of the bankruptcy process: resource allocation questions (whether to sell or reorganize a firm) are ultimately confounded with distributional questions (how much each creditor will receive) due to conflict among creditor classes.

Research has shown that the dynamics of facial motion are important in the perception of gender, identity, and emotion. In this paper we show that it is possible to use a multi-linear tensor framework to extract facial motion signatures and to cluster these signatures by gender or by emotion. Here, we consider only the dynamics of internal features of the face (e.g. eyebrows, eyelids and mouth) so as to remove structural and shape cues to identity and gender. Such structural gender biases include jaw width and forehead shape and their removal ensures dynamic cues alone are being used. Additionally, we demonstrate the generative capabilities of using a tensor framework, by reliably synthesising new motion signatures; and find results comparable to human psychology experiments performed on the same facial motion data.

The reforms of 2005 yield important but subtle changes in the Bankruptcy Code's treatment of financial contracts. They might appear only to eliminate longstanding uncertainty surrounding the protections available to financial contract counterparties, especially counterparties to repurchase transactions and other derivative contracts. But the ambit of the reforms is much broader. The expanded definitions - especially the definition of "swap agreement" - are now so broad that nearly every derivative contract is subject to the Code's protection. Instead of protecting particular counterparties to particular transactions, the Code now protects any counterparty to any derivative contract. Entire markets have been insulated from the costs of a bankruptcy filing by a financial contract counterparty. Equally important, the amendments limit judicial discretion to assess the economic substance of financial transactions, even those that resemble ordinary loans or that retire a debtor's outstanding debt or equity. The reforms of 2005 direct judges to apply a formalistic inquiry based on industry custom: a financial transaction is a "swap," "repurchase transaction," or other protected transaction if it is treated as such in the relevant financial market. The transaction's loan-like features or its effect on outstanding obligations of the debtor are irrelevant, unless they affect the transaction's characterization in financial markets. Absent fraud, form trumps substance - a desirable outcome, we argue, in light of the impossibility of drawing coherent lines between combinations of ordinary financial contracts and loans, dividends, or debt repurchases.

Chapter 11 is thought to preserve the going-concern surplus of a financially distressed business-the extra value that its assets possess in their current configuration. Financial distress leads to conflicts among creditors that can lead to inefficient liquidation of a business with going-concern surplus. Chapter 11 avoids this by providing the business with a way of fashioning a new capital structure. This account of Chapter 11 fails to capture what is happening in the typical case. The typical Chapter 11 debtor is a small corporation whose assets are not specialized and rarely worth enough to pay tax claims. There is no business worth saving and there are no assets to fight over. The focal point is not the business, but the person who runs it. She is a serial entrepreneur, searching for the business that best matches her skills. For the vast majority of cases, then, Chapter 11 is best seen through the lens of labor economics not corporate finance. Chapter 11 offers the entrepreneur increased liquidity as well as a forum for renegotiating debts (such as unpaid withholding taxes) for which she as well as the corporation are liable. But Chapter 11 offers these benefits only to entrepreneurs who remain with their existing businesses. This lock-in effect is qualitatively no different from the one commonly associated with rent control. These effects, as well as the costs the process imposes on third parties, should be the focus of any assessment of how well Chapter 11 works.

The collapse of Long Term Capital Management (LTCM) in Fall 1998 and the Federal Reserve Bank's subsequent efforts to orchestrate a bailout raise important questions about the structure of the Bankruptcy Code. The Code contains numerous provisions affording special treatment to financial derivatives contracts, the most important of which exempts these contracts from the "automatic stay" and permits counterparties to terminate derivatives contracts with a debtor in bankruptcy and seize underlying collateral. No other counterparty or creditor of the debtor has such freedom; to the contrary, the automatic stay prohibits them from undertaking any act that threatens the debtor's assets. It is commonly believed that the exemption for derivatives contracts helps reduce "systemic risk" in financial markets, that is, the risk that multiple major financial market participants will fail at the same time and, as a result, drastically reduce market liquidity. Indeed, Congress is now contemplating reforms that would extend the exemption to include a broader array of financial contracts, all in the name of reducing systemic risk. This is a mistake. The Bankruptcy Code can do little to reduce systemic risk and may in fact exacerbate it, as the experience of LTCM suggests. Risk of a systemic meltdown arose there and prompted intervention by the Fed precisely because derivatives contracts were exempt from the automatic stay. Derivatives contracts may merit special treatment, but fear of systemic risk is a red herring. A better, efficiency-based reason for treating derivatives contracts differently arises naturally from the economic theory underlying the automatic stay. The stay protects assets to the extent they are needed to preserve a firm's going-concern surplus (its value above and beyond the sale value of its assets). Assets are needed to preserve going-concern surplus only if they are firm-specific, that is, only if they are worth more inside the firm than outside it. This is often true for plant and equipment. It is never true for derivatives contracts. This observation helps rationalize the Code's treatment of derivatives contracts and other features of the automatic stay. There are, however, downsides to treating derivatives contracts differently (creditors, for example, would like to disguise loans as derivatives contracts). These downsides are probably not significant, but they highlight the fragility of the Code's treatment of derivatives contracts, which should worry members of Congress as they consider arguments to expand the Code's exemptions for derivatives contracts.

Over half of all small businesses reorganizing under Chapter 11 of the U.S. Bankruptcy Code are ultimately liquidated. Little is known about this shutdown decision and about the factors that increase or reduce the amount of time a firm spends in bankruptcy. It is widely suspected, however, that the Chapter 11 process exhibits a "continuation bias," allowing non-viable firms to linger under the protection of the court. This paper tests for the presence of continuation bias in the docket of a typical bankruptcy court over the course of a calendar year. A variety of tests are employed, including the extent to which entrenched managers dominate the bankruptcy process, the accuracy and speed with which viable and nonviable firms are distinguished, and the extent to which the hazard of shutdown is consistent with the implications of a simple, formal model of the optimal Chapter 11 process. Contrary to conventional wisdom, the paper finds that continuation bias is either absent or empirically unimportant.

The discount rate is a critical element of cost-benefit analysis. The value of cost-benefit analysis in improving regulatory decisions depends, in large part, on the reasonableness of the discount rate. Small variations in the discount rate can significantly bias the analysis. Despite the importance of the discount rate, courts have failed to develop a standard of review for agency discount rate choices. this is particularly troubling in light of evidence that agency practice exhibits wide-ranging, and generally unexplained, variation in discount rates. Not only do different agencies employ different rates, but the same agency will sometimes apply different rates to different regulations without explanation. This comment seeks to strengthen cost-benefit analysis by providing a framework for judicial review of agency discount rates. As a threshold matter, courts should find, as a matter of law, that an agency acts unreasonably if it fails to discount future costs and benefits, even if they accrue to future generations. Additionally, courts should take a "hard look" at agency discount rates and ask three basic questions: Is there a record for the agency's choice? Did the agency explain its choice between the alternative approaches to discounting, the SRTP and OCC? Did the agency consider the relevant factors in applying the chosen method? While these questions are standard fare in hard look review, they would represent a significant advance in judicial review of discount rates. More importantly, hard look review would provide strong incentives for agencies to adopt morally and economically sensible discount rates.