Bankruptcy and Corporate Governance: The Impact of Board Composition and Structure

Author(s): Catherine M. Daily and Dan R. Dalton

Source: The Academy of Management Journal , Dec., 1994, Vol. 37, No. 6 (Dec., 1994), pp.
1603-1617
Published by: Academy of Management

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? Academy of Management Journal
1994, Vol. 37, No. 6, 1603-1617.

BANKRUPTCY AND CORPORATE GOVERNANCE: THE

IMPACT OF BOARD COMPOSITION AND STRUCTURE

CATHERINE M. DAILY
Ohio State University
DAN R. DALTON
Indiana University

In this study, we examined the relationships among governance struc-

tures and corporate bankruptcy. A logistic regression analysis of bank-
rupt major corporations and a matched group of survivor firms indi-
cated robust power for financial indicators, constituent common stock
holdings, board of director quality, and corporate governance struc-
tures as predictors of bankruptcy. Specifically, the model indicates dif-
ferences between the bankrupt and matched groups in proportions of
affiliated directors, chief executives, board chairperson structure, and
their interaction.

Porter noted that "the reason why firms succeed or fail is perhaps the
central question in strategy" (1991: 95). We would argue, then, that corpo
rate bankruptcy is a particularly important context for examining strategic
management. Moreover, a review of the relevant strategic, finance, account-
ing, legal, and economics literatures led us to agree with Hambrick and
D'Aveni (1988) that large-scale corporate decline and bankruptcy is a rela-
tively unexplored domain.
The extant research in the area has addressed the extent to which a
bankruptcy filing stigmatizes a firm and consequently its ability to succe
fully restructure (Sutton & Callahan, 1987). Strongly underscoring this pe
spective is D'Aveni's work establishing that prestigious top manageme
team members often leave a firm when bankruptcy is imminent (D'Av
1990; Hambrick & D'Aveni, 1992). D'Aveni and his colleagues have als
examined the impact of bankruptcy on managerial communications to sha
holders (D'Aveni & MacMillan, 1990), traced patterns of organizational
cline (D'Aveni, 1989a; Hambrick & D'Aveni, 1988), and applied agency a
prospect theory to corporate bankruptcy (D'Aveni, 1989b).
Moulton and Thomas (1993) provided an overview of bankruptcy a
deliberate strategy and an empirical assessment of factors related to succe
ful reorganization. Corporate governance structures were not included
their analysis. There is an extensive literature concerning the extent
which the officers and directors of a bankrupt corporation are likely to re
or to be replaced (e.g., D'Aveni, 1990; Fizel & Louie, 1990; Gilson, 198

1603

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1604 Academy of Management Journal December

1990; Gilson & Vetsuypens, 1992; Wruck, 1990) and reactions of financial
market investors to announced executive changes in bankrupt firms (Bon-
nier & Bruner, 1989; Davidson, Worrell, & Dutia, 1993).
Our specific research focus was the potential relationship between
bankruptcy and two much-debated aspects of corporations: board composi-
tion, or the ratio of outside members to total members, and chief executive
officer (CEO)-board chairperson structure. Of concern is whether these of-
fices are held by one person, a structure called duality. Only two studies
have examined elements of governance structures and bankruptcy. Chaganti,
Mahajan, and Sharma (1985) found no relationship between board compo-
sition and bankruptcy in a study of 21 retailing companies. In what for us is
a provocative report, Hambrick and D'Aveni (1992) found that dominant
CEOs were more likely than weaker CEOs to be associated with firm bank-
ruptcy. Although their measurement of dominance was based on the ratio
between CEO's compensation and that of the remaining members of a firm's
top management team, their results suggest that an examination of gover-
nance structures-some of which are considered to enhance CEO power-
may be productive.

GOVERNANCE STRUCTURE

Although there is near consensus among theoreticians conce

best CEO-board chair structure-agreement that one individual
simultaneously hold the roles of CEO and board chairperson (e.g
Kesner, 1987; Mallette & Fowler, 1992; Zahra & Pearce, 1989)-th
empirical literature is not persuasive on this point. Mallette a
demonstrated that separation of the CEO and chairperson posit
associated with fewer adoptions of "poison pill" provisions. Our
tion of the Inc. 100 reported no relationship between CEO-board
son duality and a variety of performance indicators (Daily & Dal
Rechner and Dalton (1991) reported that firms with dual struc
higher financial performance than other firms.
Even at the conceptual level, there is an interesting, but m
counter argument to the "separate is better" perspective. Anderson
thony suggested that the offices of chairperson and CEO should be
as such a structure provides a focal point for leadership and a
ambiguity about responsibility; they noted that doing otherwise "i
teed to produce chaos both within the organization and in relation
the board" (1986: 54).
This unifying power may, however, be less advantageous wh
faces the period of decline preceding bankruptcy. As we noted ear
brick and D'Aveni (1992) reported that dominant CEOs were mor
be associated with firm bankruptcy. Two factors could account for
lationship. Corporate bankruptcy is not a discrete intervention
stage of a "protracted process of decline" and a "downward spi

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1994 Daily and Dalton 1605

brick & D'Aveni, 1988: 1). Corporate managements would seem to have some
opportunity to devise strategies to correct such a downward trend. Some
observers, less sanguine about this possibility, have argued that organiza-
tional adversity leads to threat-rigidity responses (Staw, Sandelands, & Dut-
ton, 1981)-conservatism, questionable escalation, reliance on past policies,
rigidity, increases in centralization and formalization, and resistance to
change (e.g., Cameron, Kim, & Whetten, 1987; Dutton & Duncan; 1987;
Singh, 1986; Staw et al., 1981; Whetten, 1987).
It may be that relatively powerful CEOs serving simultaneously as board
chairpersons use their influence not to effect change, but to keep the course.
Hambrick and D'Aveni (1988) suggested that positive changes are unlikely
under the crisis conditions in failing and bankrupt firms. Content analyses of
bankrupt firms' annual reports have indicated that managements deny crises
and shift explanations of declines toward their external environments, be-
haviors apparently consistent with threat-rigidity patterns (D'Aveni & Mac-
Millan, 1990). Also, turnaround strategies typically include the removal of
current management (e.g., Bibeault, 1982; Pfeffer & Davis-Blake, 1986; Salan-
cik & Meindl, 1984). Recent work by Mallette and Fowler (1992) underscores
this view. They reported that companies operating with a separation of the
CEO and chairperson positions were less likely to adopt poison pills; such
adoptions might be reasonably interpreted as an entrenchment strategy on
the part of powerful joint CEO-chairpersons. Perhaps it is true that "prob-
lem causers have little credibility as problem solvers" (Whetten, 1987: 349).
We suggest that duality will exacerbate tendencies toward threat-rigidity
responses. Indeed, Lorsch specifically suggested that "providing a leader [of
the board] separate from the CEO could significantly help directors prevent
crises, as well as to act swiftly when one occurs" (1989: 185). Accordingly,
Hypothesis 1: Bankrupt firms will have a greater inci-
dence of the joint CEO-board chairperson structure than
survivor firms.

As with CEO-board chairperson structure, there is little disagreement

in the conceptual literature regarding the proper configuration of corporate
boards: Effective boards will have high proportions of outside directors
(Lorsch, 1989; Mizruchi, 1983; Zahra & Pearce, 1989; but see Baysinger and
Hoskisson [1990] for a balanced discussion of an alternative view). Pfeffer
and Salancik (1978) provided an initial overview of three perspectives-
expertise, controlling or governing, and resource dependence-under-
scoring the merit of appointing outside members to boards.
Even so, there is little empirical evidence that a preponderance of out-
side board members is associated with improved corporate performance.
Zahra and Pearce noted that "past research on [board] composition has
yielded contradictory findings and suggests at most a modest level of ex-
planatory power" (1989: 310). The empirical work that has appeared since
their review is also vexing. There are reports that high outside director

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1606 Academy of Management Journal December

proportions are positively associated with corporate performance (Daily &

Dalton, 1993; Stearns & Mizruchi, 1993), are not a factor in performance
(Daily & Dalton, 1992; Kesner & Johnson, 1990), and are negatively associ-
ated with performance (Baysinger, Kosnik, & Turk, 1991; Goodstein &
Boeker, 1991).
We suspect that corporate bankruptcy is a unique context in which the
contribution of board composition to corporate performance can be effec-
tively examined. Pfeffer and Salancik noted that "one would expect that as
the potential environment pressures confronting the organization increase,
the need for outside support would increase as well" (1978: 168). For us, this
statement suggests that firms facing the prospect of steep decline and im-
pending bankruptcy may be better served by a large proportion of outside
directors on their boards. A resource dependence perspective would partic-
ularly underscore the necessity of having many external representatives on
a board in a time of crisis as their presence would provide access to valued
resources and information, facilitate interfirm commitments, and aid in es-
tablishing legitimacy (Pfeffer & Salancik, 1978). One of the primary issues
arising during crisis is the continuation of exchange relationships between a
corporation and its critical constituencies (Sutton & Callahan, 1987).
Again, we rely on the threat-rigidity thesis noted earlier. If there is CEO
resistance to adopting aggressive strategies to counter a continuing organ-
izational decline, we would think that an outsider-dominated board would
be better positioned to encourage-if not direct-the necessary change. We
know, for example, that high insider representation on boards is associated
with lower board involvement in strategic decision making (Judge & Zeith-
aml, 1992). Correspondingly, it has also been reported that boards with high
outsider representation are more likely to be strategically involved in firm
restructuring (Johnson, Hoskisson, & Hitt, 1993). This finding suggests that
boards with many outsiders may be more likely than other boards to take
action to prevent further performance declines and, ultimately, bankruptcy
itself.
Although prior research addressing issues of board governance has often
relied on board composition as a variable, the measurement of board com-
position has not been uniform. The key issue is the extent to which the
members of a firm's board are truly independent of its CEO.
Several approaches have been used to capture this perspective. One
simply focuses on the ratio of inside directors to total directors (e.g.,
Baysinger, Kosnik, & Turk, 1991; Goodstein & Boeker, 1991), as it is recog-
nized that few officers of a firm will be independent of its CEO. Other
approaches focus on the ratio of outside directors to total directors. Because
various researchers have defined outside board members differently, the
second ratio is not necessarily the complement of the first. Some authors
have defined an outside director as one who is not in the direct employ of the
corporation on whose board he or she sits (e.g., Kesner & Johnson, 1990;
Kesner, Victor, & Lamont, 1986; Singh & Harianto, 1989). Others, however,
have relied on the independent-interdependent distinction made by Wade,

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1994 Daily and Dalton 1607

O'Reilly, and Chandratat (1990) and Boeker (1992). Independent directors

are outside directors who were appointed to a board prior to a current CEO's
appointment. Interdependent directors are either inside board members or
outside directors appointed by the current CEO. Another approach (e.g.,
Boeker & Goodstein, 1993; Cochran, Wood, & Jones, 1985; Johnson et al.,
1993; Pearce & Zahra, 1991) largely captures the distinction provided by the
Securities and Exchange Commission's (SEC's) regulation 14A, item 6b,
which sets forth the conditions under which directors' affiliation with a firm
must be disclosed in proxy materials. The essence of the code is that close
personal or professional relationships with the corporation or its CEO must
be disclosed. Directors (or nominees) with the following relationships to a
firm must be identified: (1) employment by the corporation or an affiliate
within the last five years, (2) any family relationship by blood or marriage
closer than second cousin, (3) affiliation in the last two years with a concern
that has had a customer, supplier, banker, or creditor relationship with the
corporation, (4) affiliation with an investment banker who has performed
services for the corporation within two years or will do so within one year,
(5) holding control of corporate stock, with control based on the extent of
shareholdings (federal securities law sets forth exact amounts and condi-
tions), and (6) association with a law firm engaged by the corporation.
As we are persuaded that the SEC item 6b approach best captures the
notion of directors' independence in their service to a board, we used the
distinction derived from that regulation in this research. Corporate boards
with large proportions of affiliated directors, then, are characterized by little
independence from the firms' CEOs. Succinctly, although a given board
might be composed of many outside directors, if they are affiliated as defined
by SEC item 6b, they have close personal or professional ties with the cor-
poration or its CEO. Accordingly, we would argue
Hypothesis 2: Bankrupt firms will have higher propor-
tions of affiliated directors than survivor firms.

Prior discussion suggests a possible interaction between these gover-

nance elements. A governance approach characterized by separation of the
CEO and chairperson offices and a high proportion of nonaffiliated outside
directors would produce a relatively independent structure. Conversely,
combining the offices of CEO and board chairperson and having a large
number of affiliated directors suggests a more centralized approach. We have
some confidence in the viability of this interactive effect on two grounds.
Firstly, as noted above, Mallette and Fowler (1992) reported a similar inter-
action between CEO-board chairperson structure and board composition as
affecting the adoption of poison pills. Also, a CEO who simultaneously
holds the position of board chairperson and works with a board composed
largely of insiders would seem to have more institutional power than oth-
erwise situated CEOs. Interestingly, through such a structure, CEOs may be
able to forestall their own removal (Fredrickson, Hambrick, & Baumrin,
1988). Under such a centralized model, then, CEOs may not only be resistant

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1608 Academy of Management Journal December

to changes in strategy, but largely immune to replacement as well. This

relationship is consequential because, as previously noted, most observers
have suggested that effective turnaround strategies typically include the re-
moval of current management (cf. Bibeault, 1982; Pfeffer & Davis-Blake,
1986; Salancik & Meindl, 1984). Accordingly, we propose
Hypothesis 3: The interaction between CEO-board chair-
person structure and the proportion of affiliated directors
will distinguish bankrupt from survivor firms.

METHODS

The reported study employed a matched pair design of 57 b

firms and 57 surviving firms.1 The information on these firms wa
from archival sources covering the ten years from 1972 to 198
include Dun and Bradstreet, the Securities and Exchange Commissio
research by Altman (1983), and Funk and Scott's Index of Corporate
D'Aveni identified the group of firms and has used it in recent
concerning organizational prestige and managerial communications
(D'Aveni, 1990; D'Aveni & MacMillan, 1990).

Variables

Corporate bankruptcy was a binary variable. All members of the prim

group had filed bankruptcy over the period, but none of the matched gr
had done so. The bankruptcy variable is for the year in which a filin
curred. All other variables are lagged and represent circumstances five y
prior to the filing of bankruptcy.
Board composition. As previously noted, we relied on a measurement
board composition capturing the distinction provided by Securities and E
change Commission regulation 14A, item 6b, which sets forth the condit

1 As noted, D'Aveni gathered the group of 57 bankrupt firms and matching firms
comprehensively described the matching process employed (D'Aveni, 1990: 139). Essenti
set of potential matched firms was generated for each bankrupt firm. Matching criteria were f
size and sales volume ranked by three-digit Standard Industrial Classification (SIC) code
gories (from Ward's Directory) or by four-digit SIC codes (from Standard & Poor's). Data o
firm's size, products, markets, and profitability were included, drawn from Moody's Indu
and OTC Manuals. Using these criteria, three judges working independently then selected t
first and second choices to be matched to each bankrupt firm and reached a consensus o
appropriate matched firms, for all but five bankrupt firms, for which it was concluded t
were no satisfactory matches. Accordingly, the final number of matched pairs was 57
matching firms also had to be not failing. This condition was met by a firm's (1) survival
years past the year of its matched counterpart's bankruptcy and (2) having profitability i
top half of its industry in that year. Also, no firms were included that filed bankruptcy
tionally-to, for, example, obviate a collective bargaining agreement, manage ruinous pr
liability exposure, or confound a hostile takeover attempt (see Moulton and Thomas [199
a discussion of this issue).

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1994 Daily and Dalton 1609

under which directors' affiliation must be disclosed in proxy materials.2

Data were collected from the relevant proxy statements for both the bankrupt
and matched firms. The proportion of outside directors with "6b" affilia-
tions is reported.
CEO-board chairperson structure. This variable is binary. The same
individual either did or did not simultaneously serve as a firm's CEO and
board chairperson. These data were collected from Standard & Poor's Reg-
ister of Corporations, Directors, and Executives.
Composition-structure interaction. This interactive variable is the un-
weighted multiplication of a firm's CEO-board chairperson structure and its
proportion of affiliated directors.

Control Variables

Three financial indicators commonly used in bankruptcy research, pr

itability (net income divided by total assets), liquidity (current asset
vided by current liabilities), and leverage (long-term debt), were also
(e.g., D'Aveni, 1990; Flagg, Giroux, & Wiggins, 1991; Hambrick & D'Av
1988; Mallette & Fowler, 1992).
Common stock holdings were measured in four ways. The percentage
a firm's stock held by institutional investors, the officers and directors
firm, and holders of 5 percent or more of its stock were included. T
number of 5 percent stockholders was also used. These variables have
served as controls in past research (e.g., Baysinger et al., 1991; Boeker, 19
Hill & Snell, 1988; Mallette & Fowler, 1992; Wade et al., 1990).
We added another set of control variables that in concert may captur
the quality of a firm's board. Both D'Aveni (1990) and Finklestein (1992),
examinations of CEO and top management team quality, have provid
some guidance as to how board quality might be addressed. We relied
four indicators to assess the quality of a given board of directors: (1) the t
number of corporate directorships held by a firm's board members; (2) t
total number of noncorporate directorships held by a firm's board memb
(3) the number of CEOs or chairpersons who serve on a firm's board; and
educational prestige, or the number of members with undergraduate or gr
uate degrees from elite educational institutions (cf. Finkelstein, 1992).
Data on the control variables were obtained from Moody's Indust
Manual, Moody's Handbook of Common Stocks, Moody's OTC Manual,

2 Although we consider the distinction based on SEC item 6b to provide the best concep-
tualization for the independence-dependence of board members, in our analyses we directly
compared all three approaches (outside board members to total board members ratio, indepen-
dent-interdependent, SEC 6b) through three logistic regression analyses. All three approaches
significantly contributed to the model. It may be notable, however, that the SEC 6b approach
resulted in a hit rate of 94.52 percent, the independent-interdependent classification in a hit
rate of 91.78 percent, and the outside board member-total board member ratio in a rate of 92.86
percent. It appears that the more robust model-at least with regard to this bankruptcy con-
text-can be developed based on the SEC 6b distinction.

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1610 Academy of Management Journal December

Standard & Poor's Register of Corporations, Directors, and Executives, Stan-

dard & Poor's Corporation Security Owner's Stock Guide, Ward's Business
Directory of U.S. Private and Public Companies, corporate annual reports,
10-K reports, and proxy statements. We also acknowledge information pro-
vided by Disclosure, Inc., on some of these variables for individual compa-
nies in selected years.

ANALYSES

Given our use of a dichotomous dependent variable and a s

control variables and the nature of the independent variables, we
logistic regression analysis for hypotheses testing. Because the Wa
rapidly loses power as the absolute value of a regression coefficien
(e.g., Hosmer & Lemeshow, 1989; Norusis, 1990), we used the l
ratio approach, which is easily interpreted as it can be used as the
of hierarchical multiple regression analysis. Moreover, it provides
iar "hit rate" information associated with discriminant function a

RESULTS

Descriptive statistics and correlations for all variables appear in

Table 2 presents results of the logistic regression analysis. The base
of Table 2 shows a logarithmic likelihood statistic of 101.19; in a li
ratio approach, this statistic is based on the constant of the regres
tion only. We deemed the initial hit rate to be 50 percent as we kn
half the firms were bankrupt and the other half were not.
In the subsequent steps, we were able to iteratively determine t
tribution of the various sets of control variables to the model. The inclusion
of the financial variables in the first step, for example, resulted in a signif-
icant improvement (from 50 to 71.23 percent) in the rate of predicting bank-
ruptcy. The addition of other sets of control variables also improved the
logistic regression model. Common stock holdings move the hit rate to 84.93
percent, and board quality provides another increment, to 87.17 percent.
In the fourth step, the governance variables were added. All sets of
variables (financial, holdings, board quality) entered in prior steps can be
considered control variables. Having accounted for the model and hit rate
improvements as a function of all previously entered variables, in the like-
lihood ratio logistic regression we illustrate that the addition of the gover-
nance variables further enhances the model. Moreover, inspection of the
fifth step suggests that the addition of the interaction of CEO-board chair-
person structure and the proportion of affiliated directors markedly im-
proves the model as well resulting in a final hit rate of 94.52 percent. From
the signs of the coefficients, we can also see that, compared to the matched
control firms, the bankrupt firms have less profitability, less liquidity, less
equity in the hands of institutional holders, and fewer CEOs or board chair-
persons on their boards.
With regard to the specific hypotheses posited for this research, the

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 TABLE 1
Descriptive Statistics and Correlations
Variables Means s.d. 1 2 3 4 5 6 7 8

1. Profit 0.01 0.09

2. Liquidity 2.02 0.93 .51
3. Leverage 0.47 1.52 .09 1.10
4. Number of 5% holders 1.81 1.26 .22 .10 .12
5. Percentage held by 5%
holders 26.45 22.76 -.01 .01 .11 .80
6. Percentage held by
institutions 12.68 16.46 .20 -.03 -.04 -.04 -.22
7. Percentage held by
officers and directors 16.29 15.03 .01 .07 .02 .46 .63 -.36
8. Number of corporate
directorships 19.81 14.90 -.05 -.11 -.14 -.09 .00 .15 -.23
9. Number of other
directorships 5.20 4.65 -.10 -.08 -.10 .14 -.02 .11 -.10 .56
10. Number of CEOs or
chairpersons on board 1.87 1.90 .07 .01 -.25 -.07 -.07 .18 -.13 .60
11. Board educational
prestige 1.56 1.59 -.01 .04 -.01 .03 -.03 .20 -.25 .56
12. CEO-chairperson
structure 0.45 0.50 -.18 -.19 -.04 -.29 -.18 .04 -.16 .08
13. Percentage of affiliated
directors 0.52 0.24 -.28 -.33 -.23 -.15 -.24 -.12 -.32 -.09 -
14. Bankruptcy status 0.50 0.50 -.72 -.47 .18 -.02 -.09 -.43 -.12 -
a Correlations greater than .19 are significant at p < .05.

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 TABLE 2
Results of Logistic Regression Analysis

Logarithmic
Step Variables b s.e. Likelihood Model X2 Improvem
Baseline 101.19 .000
1 Financial indicators
Profitb -3.57** 1.19

Liquidityb -1.15** 0.41 72.60 28.59

Leverage
2 Common stock holdings
Number of 5% holders
Percentage held by 5% holders 51.36 21.24

Percentage held by institutionsb -0.17*** 0.05

Percentage held by officers and directors
3 Board quality
Number of corporate directorships
Number of other directorships 42.29 9.07

Number of CEOs or chairpersonsb -0.98* 0.45

Educational prestige
4 Governance
8.35**
CEO-chairperson structureb 3.60 38.31 3.98
9.64* 4.64
Percentage of affiliated directorsb
5 Interaction
Structure-compositionb 12.57* 5.54 26.91 11.40

a Pseudo-R2 = 0.32.
b The variable was a significant indicator in the step in which it was entered. Also, all variables s
the likelihood ratio method stepdown procedures.
* p < .05
** p < .01
*** p < .001

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1994 Daily and Dalton 1613

signs of the coefficients indicate that the bankrupt firms are more likely to
have CEOs serving simultaneously as board chairpersons. These firms also
have higher proportions of affiliated directors than the control firms. The
structure-composition interaction term is significant as well.
Although the analyses we report are for values of the independent vari-
ables for five years prior to the bankruptcy filings, we also conducted a
contemporaneous analysis, using values in the actual years of filings. The
consideration of only the financial indicators (profit, liquidity, and leverage)
resulted in a hit rate of 95.54 percent. No additional independent variables
add marginal predictive power to that model.

DISCUSSION

The reported results suggest a relationship between governa

tures and bankruptcy. A brief overview of the descriptive sta
provide a sharper focus. The number of dual structures was 37.5 p
survivor firms and 53.8 percent in bankrupt firms. Of the direct
vivor firms, 44.9 percent were affiliated, as compared to 59.5 per
bankrupt firms.
Although these results are promising, they should be interpre
caution and not extended beyond the focused context provide
data set comprises bankrupt firms and a matched control grou
several year period, relatively few large-scale corporations are
bankruptcy. Moreover, our results reflect the state of governance
five years prior to actual bankruptcy filings. We suspect that the
icate balance in the explanatory power of governance structure
indicators, and subsequent bankruptcy. As noted, in the actual yea
ruptcy, financial indicators alone provide a hit rate of over 95
that time, then, it appears that no intervention concerning a firm
nance structure can reasonably forestall bankruptcy. It would be
to determine at what point governance structures no longer have
dictive ability concerning future bankruptcy.
Also, the firms on which we relied for this examination w
corporations, and the results may not be generalizable to their sm
terparts. It may be, for example, that larger firms have greater as
credibility in the financial markets, and longer-term contracts an
the onset of formal bankruptcy filing well beyond the point at wh
firms can do so. Moulton and Thomas, for example, explained that
dominates all other factors in predicting success in completing th
ization process" (1993: 125).
We wonder what impact governance structure distinctions might have
after firms file for bankruptcy. It is known that few bankrupt firms ever
emerge with a confirmed plan of reorganization and with their assets rea-
sonably intact. Moulton and Thomas (1993) estimated that fewer than 10
percent of all firms entering bankruptcy could be described as successful in

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1614 Academy of Management Journal December

the post-bankruptcy period. It may be that differences in governance struc-

tures in that crucial period could be shown to affect post-bankruptcy firm
survival.
This relationship could also be an interesting subject of future research
as it may reopen investigation of the balance between governance structures
and financial condition. Sutton and Callahan (1987) agreed that firms filing
for bankruptcy protection are unlikely to survive, given their objective fi-
nancial condition. Beyond that, however, they argued that the associated
stigma of having filed for bankruptcy is an important factor in a firm's in-
ability to restructure successfully. This notion is consistent with D'Aveni's
(1990) research on patterns of top management team prestige in the years just
prior to firms' bankruptcy filings. He reported that firms do seek to improve
managerial prestige in the years prior to the filings, but are unable to sustain
these advances as many of their more prestigious officers bail out as the firms
proceed toward bankruptcy. It would be interesting to determine if a firm's
choice of governance structures has any effect on its ability to attract top
managers and board members in the post-bankruptcy period.
In our view, additional research on corporate bankruptcy is highly im-
portant. Although a perspective based on agency theory would underscore
the tension between the top-ranking officers of a corporation and other stake-
holders (e.g., Eisenhardt, 1989), a managerial decision to escort a firm into
bankruptcy may not have that character. In the short term, we could imagine
a CEO artificially postponing bankruptcy filing to guarantee compensation
for a year or two. In the longer term, however, it appears that a bankruptcy
filing is catastrophic for all parties.
The value of a firm's common stock declines 90 percent during the five
years immediately preceding its bankruptcy (Loderer & Sheehan, 1989).
Gilson's (1989, 1990) conclusions are sobering as well; he noted that (1) 52
percent of CEOs, presidents, and board chairpersons lose their positions and
are not employed in another exchange-listed firm for at least three years after
bankruptcy, (2) 54 percent of incumbent directors lose their positions on the
boards, and (3) directors who resign from bankrupt firms hold fewer seats on
other boards subsequent to their departure. Interestingly, the bankruptcy of
a firm does not even appear to be in the interests of its competitors. Lang and
Stulz (1992) determined that the bankruptcy of a given company leads to
abnormally low returns in its industry. Given the apparent consequences of
corporate bankruptcy, we would welcome research addressing factors that
may predispose a firm to bankruptcy, impede the implementation of effec-
tive counter strategies during the decline period, and permit the firm to
survive after bankruptcy.
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Catherine M. Daily is an assistant professor in the Max M. Fisher College of Business,

Ohio State University. She received her Ph.D. degree in business strategy from the
Graduate School of Business, Indiana University. Her research interests include corpo-
rate governance, strategic leadership, the dynamics of bankruptcy and business failure,
and entrepreneurship.
Dan R. Dalton is the Dow Professor of Management and associate dean of the Graduate
School of Business, Indiana University. He received his Ph.D. degree from the Univer-
sity of California. His research interests include corporate governance, managerial eth-
ics, and corporate social responsibility.

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