Information dissemination and corporate bankruptcies

Abstract

I examine informed trading around Chapter 11 corporate bankruptcy filings. Using unique bankruptcy data and improved measures of high-frequency posterior probabilities of informed trading, I document a substantial increase in informed selling several days before bankruptcy announcements. This pre-announcement informed selling attenuates subsequent announcement returns, suggesting that part of the private information embedded in informed selling was already incorporated into stock prices before the announcement. This attenuation effect of informed selling on stock market reactions is weaker for firms that receive more media coverage or adverse news sentiment. I further show that the informed trading documented is most likely driven by private information and that post-announcement informed trading can predict subsequent bankruptcy outcomes. I also investigate the liquidity dynamics of unsecured creditor stocks around their debtors’ Chapter 11 bankruptcy filings. Using matched pair fixed effect panel regressions, I find that creditors experience a short-term reduction in stock liquidity after their debtors declare bankruptcy. This is evidenced by an increase in the pairwise differences in the relative effective spread, realised spread, and lambda as well as the drop in the bid depth differential between creditors and the matched firms. This short-term liquidity reduction effect is much stronger for creditors with high credit exposure to bankrupt debtors. In the longer term, debtors’ bankruptcy announcements do not affect spread measures, but increase market depth measures of creditor stocks.