Do Size and Diversification Type Matter? an Examination of Post-Bankruptcy Outcomes

In her sample of 806 firms, Hotchkiss found that only 24% (197) successfully reorganized and 49% (97) of those firms survived for five years after reorganization. Moreover, Hotchkiss found that the five-year post-reorganization performance of these 97 firms was significantly less than their respective industry averages. Additionally, Hotchkiss (1995) found evidence to suggest that retention of pre-bankruptcy management hindered post-bankruptcy performance. We feel that a logical extension in this line of study is to examine the effect of diversification type and organizational size on post-bankruptcy outcomes. This is because strategic type has been found to affect transition performance and recovery times of firms undergoing dramatic reorganization (Dawley et al., 2002; Lamont et al., 1994; Hoskisson, 1987), and that prior research suggests that larger organizations possess larger amounts of "slack" resources that can be drawn upon during difficult times (Flynn and Farid, 1991; Moulton and Thomas, 1993). The current study examines the effect of diversification type and organizational size on probability of recovery and recovery times for firms emerging from bankruptcy protection. In this study, probability of recovery is defined to be the odds (or likelihood) that a bankrupt firm will return to a level of performance on par with its industry, and recovery time is the number of years it takes for a bankrupt firm to return to that level of performance. The effect of organizational size on survival, reorganization, and post-bankruptcy performance seems important given the growing body of literature that suggests greater size (typically measured by a firm's total assets) engenders stakeholder support, community legitimacy, and assorted ecological selection enablers that may help keep the distressed firm afloat (Bantu, 1996). Similarly, choice of diversification type might also enhance the performance of troubled forms (Grant, 1988; Hoskisson, 1987; Lamont et al., 1994). It is important to note that diversification strategy can take several forms, including geographic (e.g., degree of internationalization) and product. This study is concerned with product diversification strategy. Product diversification strategy is often defined as one of two types--related and unrelated (Rumelt, 1974; Hoskisson et al., 1993; Palepu, 1985). Firms employing related diversification strategies typically sell one product line to one industry (often defined by a 2, 3, or 4-digit standard industry classification (SIC) code (e.g., Nike). Firms employing unrelated diversification strategies sell two or more product lines to two or more distinct industries (e.g., General Electric). The performance implications of employing either of these strategies are discussed below. An organization's management has two choices when filing for bankruptcy. First, it can request time to formulate a reorganization plan with the intent of continuing operations known as "Chapter 11, Reorganization. " Second, it can turn over control of the organization's assets to a court-appointed trustee. This trustee will then sell the assets and distribute the funds under "Chapter 7, Liquidation. " This study concentrates on the Chapter 11 reorganization filings and considers Chapter 7 liquidation filings as organizational death. Thus, unless otherwise specified, bankruptcy will be used in the context of Chapter 11, reorganization filing. Furthermore, a successful reorganization is considered to exist whenever the reorganization plan is approved by the Bankruptcy Court. The existing research in bankruptcy has been examined from the financial and accounting perspective (e.g., Altman et al., 1977), the legal perspective of asset distribution and venue (e.g., Bradley and Rosenzweig, 1992), the environmental perspective of corporate legitimacy and prestige (e.g., Thompson, 1967), and the behavioral perspective of the Board of Directors (BOD) and the Top Management Team (TMT) (e. …