When firms emerge from Chapter 11 bankruptcy of the US Bankruptcy Code historic accounting valuations are cancelled and replaced with updated synthetic market value estimates in order to give the firm a fresh start. We find that distress oriented hedge funds that follow a loan to own investment strategy (i.e. vulture funds that acquire distressed debt that is swapped for equity in the emerging firm) strategically influence the fresh start accounting value of the Chapter 11 firm. Holding critical positions in the capital structure of the distressed firm grants vulture funds great influence over the bankruptcy negotiations and the determination of the fresh start value. They have strong incentives to influence fresh start valuations because the effective implementation of a loan to own strategy critically depends on the value of their equity position at emergence. We test for such influence by looking at changes in firm value before and after emergence from Chapter 11. We find that the vulture funds that hold strategic debt positions can maximize their returns by driving down firm value at the emergence of Chapter 11 and then they are pleased to see them being driven up when actual market trading commences.

--

financial distress, bankruptcy, debt trading, market values, fresh start valuation