Does Industry-wide Distress Affect Defaulted Firms? - Evidence from Creditor Recoveries

Using data on defaulted firms in the United States over the period 1982 to 1999, we show that creditors of defaulted firms recover significantly lower amounts in present-value terms when the industry of defaulted firms is in distress. We investigate whether this is purely an economic-downturn effect or also a fire-sales effect along the lines of Shleifer and Vishny (1992). We find the fire-sales effect to be also at work: Creditors recover less if the industry in distress is characterized by assets that are specific, or in other words, not easily redeployable by other industries, the industry is more levered and has fewer firms, and the surviving firms in the industry are illiquid. These industry-distress effects are economically significant and robust to contract-specific, firm-specific, macroeconomic, and bond-market supply effects. We also document that defaulted firms in distressed industries are likely to spend more time in bankruptcy, a factor that likely contributes to lower recoveries, and these firms are more likely to emerge as restructured firms than to be acquired or liquidated.