Control benefits and CEO discipline in automatic bankruptcy auctions

Abstract

In Sweden, a bankruptcy filing automatically terminates CEO employment and places the firm in an open auction. This has prompted warnings of strong shareholder risk-shifting incentives to delay filing ("go for broke"). However, during severe distress, equity incentives are weak while CEO incentives to preserve private benefits of control are strong. We show that the CEO may temporarily override risk-shifting incentives, even if she owns a substantial proportion of the firm’s equity. Depending on the available investment opportunities, such managerial conservatism may result in firm-value maximizing behavior. Examining Swedish bankruptcies, we find that proxies for CEO control benefits as well as managerial quality are significant determinants of the dramatic CEO wage loss from filing, and of the probability of the CEO being rehired by the buyer in the auction. The expected value of private control benefits increases in the CEO’s quality reputation (through the rehiring decision), alleviating to some extent concerns with entrenchment. We also find that firms sold as going concerns generate a post-bankruptcy operating profitability at par with industry rivals.