Stiffing the Creditor: The Effect of Asset Verifiability on Bankruptcy

Evidence suggests that asset pledgeability, debt complexity, and valuable control rights of dispersed debt influence distress resolution. We model how courts' imperfect verifiability of assets and valuable creditor control shape firms' debt structure and create coordination problems that determine distress outcomes and financing. We test the model's predictions using an exogenous variation in courts' ability to price assets: The 1999 U.S. Supreme Court surprise ruling requiring reorganization plans that keep stockholders' interest to be exposed to a "market test". We provide novel evidence showing that an improvement in creditor protection significantly increases bankruptcy filings and debt capacity of low-verifiability firms.