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Investing in Bankrupt Stocks: Is It a Sweet Trick?

Year 2013, Volume: 2 Issue: 4, 33 - 49, 01.12.2013

Ben Branch Min Xu

Abstract

We track the holding period return from investing in bankrupt stocks using a buy-and-hold strategy, buying the stocks on the bankruptcy filing date and holding them until the final resolution date (reorganization or liquidation). We find that holding a simple long position in the bankrupt stocks will generally lead to a large loss. The holding period return computed from the stock price alone cannot show the entire story. When considering final distributions plus the stock price, we seea much greater loss. In our regression analysis, we find that liquidity is always a key factor in explaining the returns. Profitability and information uncertainty plays a significant role in explaining the positive returns, while liquidity and (un)profitability are the two key issues associated with the negative returns. In addition, the involvement of hedge funds does not seem to be associated with better stock performance.

Keywords

Chapter 11 bankruptcy holding period return.

References

  • Aharony, J., Jones, C. P., and Swary, I. (1980), An Analysis of Risk and Return Characteristics of Corporate Bankruptcy Using Capital Market Data, Journal of Finance, Vol.35, p.1001-1016.
  • Alderson, M.J. and Betker, B. (1999),Assessing Post-Bankruptcy Performance: An Analysis of Reorganized Firm’s Cash Flows,Financial Management, Vol.28, No.2, p.68-82.
  • Altman, E. (1968), Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy,Journal of Finance, Vol.23, p.589-609.
  • Altman, E. I. (1969), Bankrupt Firms' Equity Securities as an Investment Alternative, Financial Analysts Journal, Vol.25, p.129-133.
  • Blume, M. E., Keim, D. B. and Patel, S. A. (1991), Returns and Volatility of Low-Grade Bonds 1977-1989, Journal of Finance, Vol.46, p.49-74.
  • Branch, B., and Russel, P. (2001), Penny Stocks of Bankrupt Firms: Are They Really a Bargain?Business Quest.
  • Bris, A., Welch, I., and Zhu, N. (2006), The Costs of Bankruptcy: Chapter 7 Liquidation vs. Chapter 11 Reorganization, Journal of Finance, Vol.61, p.1253-1305.
  • Brown, S. and Warner, J. (1980), Measuring Security Price Performance, Journal of Financial Economics, Vol.8, p.205-258.
  • Campbell, J., Hilscher, J., and Szilayi, J.(2008), In Search of Distress Risk, Journal of Finance, Vol.63, Issue 6, p.2557–3098.
  • Carhart, M. (1997), On Persistence in Mutual Fund Performance, Journal of Finance, Vol.52, p.57Chen, J., Hong, H. and Stein, J. C. (2002), Breadth of Ownership and Stock Returns, Journal of Financial Economics, Vol.66, p.171-205.
  • Clark, T. A., and Weinstein, M. I. (1983), The Behavior of the Common Stock ofBankrupt Firms, Journal of Finance, Vol.38, p.489-504.
  • Coelho, L. and Taffler, R. (2008), The Chapter 11 Bankruptcy Anomaly, Working paper,available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1102598.
  • Coelho, L. and Taffler, R., Working paper, 2008, Market Underreaction to Bad News: the Case of Bankruptcy Filing.
  • Datta, S. and Iskandar-Datta, M. E. (1995), The Information Content of Bankruptcy Filing on Security-holders of the Bankrupt Firm: An Empirical Investigation, Journal of Banking and Finance, Vol.19, p.903-919.
  • Dawkins, M., Bhattacharya, N., and Bamber, L. (2007), Systematic Share Price Fluctuations after Bankruptcy Filings and the Investors Who Drive Them,Journal of Financial and QuantitativeAnalysis, Vol. 42, p.399-420.
  • Dawkins, M. and Rose-Green, E. (1998), Prior Wall Street Journal Announcements of Possible Bankruptcy Filings and Price Reactions to Subsequent Bankruptcy Filing, Journal of BusinessFinance & Accounting, Vol.25, p.813-827.
  • Denis, D.K. and Rodgers K. J. (2007), Chapter 11: Duration, Outcome, and Post-reorganization Performance,Journal of Financial and Quantitative Analysis.
  • Dichev, I. (1998), Is the Risk of Bankruptcy a Systematic Risk?Journal of Finance, Vol.53, Eberhart, A. C., Altman, E. I. and Aggarwal, R. (1999), The Equity Performance of Firms Emerging from Bankruptcy, Journal of Finance, Vol.54, p.1855-1868.
  • Fama, E., and K. French (1992), The Cross-Section of Expected Stock Returns, Journalof Finance, Vol.47, p.427-465.
  • Fama, E., and K. French (1993), Common Risk Factors in the Returns on Stocks and Bonds,Journal of Financical Economics,Vol.33, p.3-56.
  • Gilson, S. (1995), Investing in Distressed Situations: A Market Survey,Financial Analysts Journal, Vol.51, p.8-27.
  • Gilson, S.C., Hotchkiss, E.S. and Ruback, R. S. (2000), Valuation of Bankrupt Firms, Review of Financial Studies. Vol.13, Iss.1, p.32-43.
  • Griffin, J. and Lemmon, M. (2002), Book-to-Market Equity, Distress Risk, and Stock Returns, Journal of Finance, Vol.57, p.2317-2336.
  • Hotchkiss, E. S. (1995), Post-Bankruptcy Performance and Management Turnover,Journal of Finance, Vol.50, p.3-21.
  • Jegadeesh, N. and Titman, S. (1993), Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, Journal of Finance, Vol.48, p.65-91.
  • Jiang, G., Lee, C., and Zhang, Y. (2005), Information Uncertainty and Expected Returns, Review of Accounting Studies, Vol.10, p.185-221.
  • Johnson, D. (1989), The Risk Behavior of Equity of Firms Approaching Bankruptcy, Journal of Financial Research, Vol.12, p.33-50.
  • Kalay, A.,Singhal, R., and Tashjian, E. (2007), Is Chapter 11 Costly?Journal of Financial Economics, Vol.84, p.772-796.
  • Michel, A., and Shaked, I. (1998), After Bankruptcy: Can Ugly Ducklings Turn Into Swans?Financial Analyst Journal, Vol. 54, No. 3, p.31-40.
  • Kothari, S. and Warner, J. (1997), Measuring Long-Horizon Security Price Performance,Journal of Financial Economics, Vol.43, p.301-339.
  • Lang, L. and Stulz, R. (1992), Contagion and Competitive Intra-Industry Effects of Bankruptcy Announcements: An Empirical Analysis, Journal of Financial Economics, Vol.32, p.45-60.
  • Li, L. and Zhong, K. (2013), Investing in Chapter 11 Stocks: Liquidity and Performance,Journal of Financial Markets, Vol.16, Issue 1, p.33–60.
  • Loughran, T. and Ritter, J. (1995), The New Issue Puzzle, Journal of Finance, Vol.50, p.23-51.
  • Maksimovic, V. and Phillips, G. (1998), Asset Efficiency and Reallocation Decisions of Bankrupt Firms,Journal of Finance, Vol.53, p.1495-1532.
  • Merton, R. (1974), On the Pricing of Corporate Debt: the Risk Structure of Interest Rates, Journal of Finance, Vol.29, p.449-70.
  • Morse, D., and Shaw, W. (1988), Investing in Bankrupt Firms, Journal of Finance, Vol.43,p.1193120
  • Miller, E. M. (1977), Risk, Uncertainty and Divergence of Opinion, Journal of Finance, Vol. 32, Opler, T. and Titman, S. (1994), Financial Distress and Corporate Performance, Journal of Finance, Vol.49, p.1015-1040.
  • Rose-Green, E. and Dawkins, M., (2002), Strategic Bankruptcies and Price Reactions to Bankruptcy Filings, Journal of Business Finance & Accounting, Vol.29, p.1319-1335.
  • Zhang, X. (2006), Information Uncertainty and Stock Returns, Journal of Finance, Vol.61, p.1051

Year 2013, Volume: 2 Issue: 4, 33 - 49, 01.12.2013

Ben Branch Min Xu

Abstract

References

  • Aharony, J., Jones, C. P., and Swary, I. (1980), An Analysis of Risk and Return Characteristics of Corporate Bankruptcy Using Capital Market Data, Journal of Finance, Vol.35, p.1001-1016.
  • Alderson, M.J. and Betker, B. (1999),Assessing Post-Bankruptcy Performance: An Analysis of Reorganized Firm’s Cash Flows,Financial Management, Vol.28, No.2, p.68-82.
  • Altman, E. (1968), Financial Ratios, Discriminant Analysis and the Prediction of Corporate Bankruptcy,Journal of Finance, Vol.23, p.589-609.
  • Altman, E. I. (1969), Bankrupt Firms' Equity Securities as an Investment Alternative, Financial Analysts Journal, Vol.25, p.129-133.
  • Blume, M. E., Keim, D. B. and Patel, S. A. (1991), Returns and Volatility of Low-Grade Bonds 1977-1989, Journal of Finance, Vol.46, p.49-74.
  • Branch, B., and Russel, P. (2001), Penny Stocks of Bankrupt Firms: Are They Really a Bargain?Business Quest.
  • Bris, A., Welch, I., and Zhu, N. (2006), The Costs of Bankruptcy: Chapter 7 Liquidation vs. Chapter 11 Reorganization, Journal of Finance, Vol.61, p.1253-1305.
  • Brown, S. and Warner, J. (1980), Measuring Security Price Performance, Journal of Financial Economics, Vol.8, p.205-258.
  • Campbell, J., Hilscher, J., and Szilayi, J.(2008), In Search of Distress Risk, Journal of Finance, Vol.63, Issue 6, p.2557–3098.
  • Carhart, M. (1997), On Persistence in Mutual Fund Performance, Journal of Finance, Vol.52, p.57Chen, J., Hong, H. and Stein, J. C. (2002), Breadth of Ownership and Stock Returns, Journal of Financial Economics, Vol.66, p.171-205.
  • Clark, T. A., and Weinstein, M. I. (1983), The Behavior of the Common Stock ofBankrupt Firms, Journal of Finance, Vol.38, p.489-504.
  • Coelho, L. and Taffler, R. (2008), The Chapter 11 Bankruptcy Anomaly, Working paper,available at SSRN: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1102598.
  • Coelho, L. and Taffler, R., Working paper, 2008, Market Underreaction to Bad News: the Case of Bankruptcy Filing.
  • Datta, S. and Iskandar-Datta, M. E. (1995), The Information Content of Bankruptcy Filing on Security-holders of the Bankrupt Firm: An Empirical Investigation, Journal of Banking and Finance, Vol.19, p.903-919.
  • Dawkins, M., Bhattacharya, N., and Bamber, L. (2007), Systematic Share Price Fluctuations after Bankruptcy Filings and the Investors Who Drive Them,Journal of Financial and QuantitativeAnalysis, Vol. 42, p.399-420.
  • Dawkins, M. and Rose-Green, E. (1998), Prior Wall Street Journal Announcements of Possible Bankruptcy Filings and Price Reactions to Subsequent Bankruptcy Filing, Journal of BusinessFinance & Accounting, Vol.25, p.813-827.
  • Denis, D.K. and Rodgers K. J. (2007), Chapter 11: Duration, Outcome, and Post-reorganization Performance,Journal of Financial and Quantitative Analysis.
  • Dichev, I. (1998), Is the Risk of Bankruptcy a Systematic Risk?Journal of Finance, Vol.53, Eberhart, A. C., Altman, E. I. and Aggarwal, R. (1999), The Equity Performance of Firms Emerging from Bankruptcy, Journal of Finance, Vol.54, p.1855-1868.
  • Fama, E., and K. French (1992), The Cross-Section of Expected Stock Returns, Journalof Finance, Vol.47, p.427-465.
  • Fama, E., and K. French (1993), Common Risk Factors in the Returns on Stocks and Bonds,Journal of Financical Economics,Vol.33, p.3-56.
  • Gilson, S. (1995), Investing in Distressed Situations: A Market Survey,Financial Analysts Journal, Vol.51, p.8-27.
  • Gilson, S.C., Hotchkiss, E.S. and Ruback, R. S. (2000), Valuation of Bankrupt Firms, Review of Financial Studies. Vol.13, Iss.1, p.32-43.
  • Griffin, J. and Lemmon, M. (2002), Book-to-Market Equity, Distress Risk, and Stock Returns, Journal of Finance, Vol.57, p.2317-2336.
  • Hotchkiss, E. S. (1995), Post-Bankruptcy Performance and Management Turnover,Journal of Finance, Vol.50, p.3-21.
  • Jegadeesh, N. and Titman, S. (1993), Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency, Journal of Finance, Vol.48, p.65-91.
  • Jiang, G., Lee, C., and Zhang, Y. (2005), Information Uncertainty and Expected Returns, Review of Accounting Studies, Vol.10, p.185-221.
  • Johnson, D. (1989), The Risk Behavior of Equity of Firms Approaching Bankruptcy, Journal of Financial Research, Vol.12, p.33-50.
  • Kalay, A.,Singhal, R., and Tashjian, E. (2007), Is Chapter 11 Costly?Journal of Financial Economics, Vol.84, p.772-796.
  • Michel, A., and Shaked, I. (1998), After Bankruptcy: Can Ugly Ducklings Turn Into Swans?Financial Analyst Journal, Vol. 54, No. 3, p.31-40.
  • Kothari, S. and Warner, J. (1997), Measuring Long-Horizon Security Price Performance,Journal of Financial Economics, Vol.43, p.301-339.
  • Lang, L. and Stulz, R. (1992), Contagion and Competitive Intra-Industry Effects of Bankruptcy Announcements: An Empirical Analysis, Journal of Financial Economics, Vol.32, p.45-60.
  • Li, L. and Zhong, K. (2013), Investing in Chapter 11 Stocks: Liquidity and Performance,Journal of Financial Markets, Vol.16, Issue 1, p.33–60.
  • Loughran, T. and Ritter, J. (1995), The New Issue Puzzle, Journal of Finance, Vol.50, p.23-51.
  • Maksimovic, V. and Phillips, G. (1998), Asset Efficiency and Reallocation Decisions of Bankrupt Firms,Journal of Finance, Vol.53, p.1495-1532.
  • Merton, R. (1974), On the Pricing of Corporate Debt: the Risk Structure of Interest Rates, Journal of Finance, Vol.29, p.449-70.
  • Morse, D., and Shaw, W. (1988), Investing in Bankrupt Firms, Journal of Finance, Vol.43,p.1193120
  • Miller, E. M. (1977), Risk, Uncertainty and Divergence of Opinion, Journal of Finance, Vol. 32, Opler, T. and Titman, S. (1994), Financial Distress and Corporate Performance, Journal of Finance, Vol.49, p.1015-1040.
  • Rose-Green, E. and Dawkins, M., (2002), Strategic Bankruptcies and Price Reactions to Bankruptcy Filings, Journal of Business Finance & Accounting, Vol.29, p.1319-1335.
  • Zhang, X. (2006), Information Uncertainty and Stock Returns, Journal of Finance, Vol.61, p.1051
There are 39 citations in total.

Details

Journal Section Articles
Authors

Ben Branch This is me

Min Xu This is me

Publication Date December 1, 2013
Published in Issue Year 2013 Volume: 2 Issue: 4

Cite

APA Branch, B., & Xu, M. (2013). Investing in Bankrupt Stocks: Is It a Sweet Trick?. Journal of Business Economics and Finance, 2(4), 33-49.

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