“America has the only legal system that in a sense actually encourages a company to seek bankruptcy protection long before a full blown financial collapse is near, allowing a business to file Chapter 11 petition even though it is not insolvent” (Labaton, 1990)
If the firm defaults, it can either reorganize through a private workout a formal bankruptcy filing, or it can liquidate its assets. The equity holders in control of the firm make this decision based on equity value in three alternative situations: 1. Continuation 2. Reorganization and 3. Liquidation. Findings suggest that Chapter 11 reorganizations are more beneficial to firms with more liquid assets and higher market value prior to filing for bankruptcy. (Aivazian and Zhou, …show more content…
Reorganized firms may emerge from Chapter 11 bankruptcy within a few months or in a few years, depending on the size and complexity of the bankruptcy. (Zhang, 2010) Debtors can often manipulate the creditors since the management of the debtor has control of the reorganization plan under Chapter 11.The debtor can often manipulate the creditor because unsecured creditors fear if they do not give in to managements desires, the Chapter 11 will be converted into Chapter 7 liquidation, which would leave debts unpaid. (Payne and Hogg, 1994) During Chapter 11 Hotchkiss 1995 reports that 40% of reorganized firms continue to experience operating losses in the three years following bankruptcy. Hotchkiss findings imply that Chapter 11 does not help firms that are in financial distress, it just enables them. Denis and Rodger (2007) relate the post reorganization operating performance of filing firms to firm and industry characterises and find that firms that significantly restructure their assets and liabilities during Chapter 11 are more likely to achieve positive industry adjusted operating performance in the three years following emergence from bankruptcy. “Like Hotchkiss, we examine operating performance around Chapter 11 filings and …show more content…
(Borenstein and Rose, 1995) Many consider Chapter 11 reorganization to be an indirect subsidy that gives weak airlines an unfair advantage by allowing them to stop making debt payments freeing up cash to expand routes and continue predatory pricing to the detriment of their competitors. (Zhang, 2010) Allowing airlines that are financially weak to survive does more harm than good to the profitability of the industry, why are airlines still allowed to file for Chapter 11? On the other side, if airlines were allowed to fail, there would no longer be any airlines since all of the airlines in the United States have filed for bankruptcy at least