Indirect Bankruptcy Costs: Evidence from Swedish Bankruptcies

Abstract

We estimate direct and indirect bankruptcy costs for 23 traded Swedish firms with completed bankruptcy procedures. We estimate direct costs of bankruptcy to on average 0.81-5.48% of enterprise value prior to financial distress and indirect costs of bankruptcy to on average 58-79%. Our analysis builds on previous work by Andrade and Kaplan (1998). In contrast to U.S. bankruptcy laws, Swedish procedures force a court appointed bankruptcy trustee to auction off the firm as parts or as an on-going concern. The characteristics of our Swedish data thus enable us to estimate the market value of firms after the occurrence of bankruptcy. We combine that data with estimates of direct costs of bankruptcy and data on the market value of firms before onset of financial distress in order to estimate the indirect costs of bankruptcy for each firm in our sample. We conclude that indirect costs of bankruptcy are of significant importance in firms’ capital structure decision and that direct costs of bankruptcy should be of trivial importance. Further, our results indicate that Swedish bankruptcy regulations may have an augmenting effect on indirect costs of bankruptcy.