Product Market Interactions and the Propensity to Restructure in Bankruptcy

In this paper we model the spillovers from the restructuring of a financially distressed firm on other firms and the feedback effects from the restructuring. Our results indicate that the spillover and feedback effects are complex and are determined by several factors including the level of information asymmetry regarding the restructuring firm, its direct bankruptcy cost, bankruptcy’s effect on its competitiveness, and the nature of its economic linkages with the other firms. For example, when the information asymmetry about a firm’s prospects is sufficiently high, its bankruptcy can lower both its competitor’s stock price and the probability that the competitor will restructure in bankruptcy, while raising the price of its competitor’s debt. A sufficiently large decline in the level of information asymmetry can cause these price and bankruptcy probability effects to reverse. Switching from competitive to a customer-supplier relationship also reverses the price and bankruptcy probability spillover effects. JEL Classification Codes: G33;