Corporate reorganization as labor insurance in bankruptcy

How does corporate reorganization affect labor outcomes in bankruptcy? The existing literature argues that corporate reorganization affects labor reallocation because it retains workers in bankrupt firms. One the one hand, firms can remain alive for too long and retain workers inefficiently. On the other hand, reorganization reduces the probability of inefficient liquidation.

This paper tests the hypothesis that job contracts are a form of insurance in times of adversity; that reorganization improves labor outcomes because it reduces the probability that workers lose the insurance provided by job contracts when the costs of job loss are high.

The paper tests this hypothesis empirically using data from Portuguese reorganization cases and has three main findings. First, in five years only about 20% of the workforce remains in reorganized firms: many workers from reorganized firms find jobs in new employers. There is no evidence that reorganization affects the reallocation of labor to efficient or profitable firms. Second, reorganization is an important source of labor insurance against negative production shocks: reorganization has a persistent and positive effect on wages and reduces the scarring effect of bankruptcy on job functions. Third, reorganization improves job transitions to new employers: reorganization reduces the probability that workers move to low-paying jobs and increases the probability that workers find high-paying jobs in new employers.

Overall, the results show that corporate reorganization is an important source of labor insurance in bankruptcy, thereby mitigating the scarring effect of job loss.

Click here to go to the paper by Diana Bonfim and Gil Nogueira.