Should investors buy stock in companies that are in bankruptcy but still trading on an exchange? Hardly. Two hundred eleven of the firms filing for backruptcy during 1984 - 1993 remained listed on the NYSE, the Amex, or the Nasdaq for at least one month after filing. The authors' analysis of returns on these stocks reveals that the exchanges' decision to maintain trading in such firms turns out to have been a poor one for investors. Those buying stock in these companies lost all their money in over one-third of the firms and experienced substantial losses on average, especially on Nasdaq firms.
TO SUBSCRIBE TO THE QUARTERLY REVIEW OF ECONOMICS AND FINANCE: Contact JAI Press, Inc., 55 Old Post Rd., No. 2, Greenwich, CT 06836. Phone: (203) 661-7602. Fax: (203) 661-0792. Recent newspaper articles have reported cases where exchange-listed stocks of bankrupt companies have traded at prices well above the value allocated to shareholders under the reorganization plan submitted to the Bankruptcy Court. The articles provide examples of stocks trading at over a dollar a share, when everybody knows that the stockholders will receive less than a dime under the terms of the reorganization. Can the stock market be as woefully inefficient as these articles suggest, or do investors in these securities have some reasonable hope that the terms of the reorganization will be modified to their benefit? In this study we examine a large sample of bankrupt companies who have submitted reorganization plans. Our evidence indicates that stockholders of these companies have unreasonably high expectations about their future prospects.
Citizens Utilities Company (CU), Stamford, CT, has two classes of common stock, one paying cash dividends and one paying stock dividends, Unless CU shareholders ignore dividend taxation, the price of the cash dividend shares should increase relative to the stock dividend shares after the 1986 tax change, Contrary to this hypothesis, we find that the relative valuation of these two classes of shares was not permanently affected by the tax change. We do observe a pricing change around the time of the tax reform, but the effect is only temporary-the relative valuation before the tax change (1982-1984) and after (1987-1989) is almost equal. Two possible explanations for the observed valuation of the two stocks are clientele effects and differences in liquidity. We find that neither of these explanations can account for the relative pricing of the shares.
Should investors buy stock in companies that are in bankruptcy but still trading on an exchange? Hardly. Two hundred eleven of the firms filing for backruptcy during 1984 - 1993 remained listed on the NYSE, the Amex, or the Nasdaq for at least one month after filing. The authors' analysis of returns on these stocks reveals that the exchanges' decision to maintain trading in such firms turns out to have been a poor one for investors. Those buying stock in these companies lost all their money in over one-third of the firms and experienced substantial losses on average, especially on Nasdaq firms.
