Life After Bankruptcy - An explorative study on how past bankruptcy experience of directors and CEOs affects a firm's risk-taking, performance and chance of survival

Abstract: This paper examines the effects of directors' and CEOs' past bankruptcy experiences on firms' outcomes. We argue that for individuals who have been involved in a corporate bankruptcy, the experience could either bring about a learning effect ("Hot-Stove mechanism"), or confirm their pre-existing behavioural biases ("Innate Risk-Taking mechanism). We rely on the Upper Echelon theory developed by Hambrick and Mason (1984) as a base for our claims. We build on the literature that has used past bankruptcy experience to explain individuals' psychological traits and attitudes towards risk. Our hypotheses are tested on a sample of 97,319 Swedish private limited liability companies between 1998 and 2015. We find significant evidence that firms employing what we define to be bankruptcy experienced directors and CEOs have higher levels of leverage, hold less cash, have lower operating performance and have a lower probability to survive if compared to similar firms with directors and CEOs having no bankruptcy experience. The results are thus consistent with what we define as "Innate Risk-Taking mechanism". We believe that these findings are particularly relevant for capital investors of private firms with bankruptcy experienced directors and CEOs.