International Review of Law and Economics 29 (2009) 229–243 Contents lists available at ScienceDirect International Review of Law and Economics The influence of bankruptcy law on equity value of financially distressed firms: A European comparative analysis Carlos López Gutiérrez ∗ , Myriam García Olalla, Bego ˜ na Torre Olmo University of Cantabria, Spain article info JEL classification: G33 G38 G14 Keywords: Corporate insolvency Financial restructuring processes Bankruptcy law Market valuation abstract The reaction of stock prices to bankruptcy filing has been frequently analysed in the financial literature. In this paper we adopt a different approach to that of traditional study, and endeavour to determine whether the reaction of markets is conditioned by the orientation of bankruptcy law. Our results lead us to conclude that it is actually the type of bankruptcy law that conditions the valuation of firm’s stocks. We have also found that the drop in share value is greater in creditor-oriented systems, while the negative returns are lower in debtor-oriented systems. © 2009 Elsevier Inc. All rights reserved. 1. Introduction The reaction of financial markets when a firm files for bankruptcy has been the object of numerous studies in which schol- ars have tried to analyse the motives which explain the market response to these situations. Different methodologies have revealed that there is a negative reaction to bankruptcy filing announce- ments, as revealed in studies carried out in different markets. 1 This reaction is justified by the informative signal with which the com- pany discloses that it has financial problems. However, in addition to this negative signal, the various mechanisms that the bankruptcy law stipulates in order to confront this situation also have an influ- ence. In this regard, the different corporate insolvency codes are not homogeneous, varying significantly even among the most devel- oped economies (Espina, 1999; Franks, Nyborg, & Torous, 1996; White, 1996). The current study has two objectives: first, to analyse whether the market value of the equity of insolvent firms is affected by the orientation of the bankruptcy law of the country concerned; and second, to determine some of the factors encouraging this reaction in countries with legislation oriented in a particular direction. This is the first empirical study to analyse the reaction of the share values ∗ Corresponding author. University of Cantabria, Business Administration Depart- ment, Avda de Los Castros S/N, Santander 39005, Cantabria, Spain. E-mail address: carlos.lopez@unican.es (C. López Gutiérrez). 1 See the work of Aharony et al. (1980), Clark and Weinstein (1983), Gilson et al. (1990), Rimbey et al. (1995), Ferris et al. (1996) or Indro et al. (1999) for the United States market, Lasfer et al. (1996) for the United Kingdom, or González Méndez and González Rodríguez (2000) and López Gutiérrez et al. (2005) for the Spanish market. according to the differences in the bankruptcy laws. Thus, the main contribution of the study lies in the application of the theoretical developments and looking at the most relevant characteristics of the regulations, to check whether the fall in market share values is determined by the orientation of the bankruptcy law. Although it is true that this cannot be considered a definitive measure enabling us to identify one type of legislation as superior to another, it does offer a new view of the problem, contributing factors for discussion that are additional to the extensive literature which has addressed the question from a conceptual perspective. In addition, we have developed an index which quantifies the degree to which a certain regulation is oriented in favour of the debtor or the creditors. Its inclusion in a multivariable analysis helps to explain the evaluation of insolvent companies by the market. Thus, one salient feature is the sample used, which is made up of companies that declared insolvency between 1990 and 2002 in Ger- many, Spain, France and the United Kingdom, which adds another value to the empirical study, and especially so because it focuses on European Union countries. Finally, an in-depth study of the economic implications deriv- ing from the characteristics of bankruptcy legislation is proposed. These take the interpretation of their orientation beyond a mere share out of value between two parties with opposing interests, as the measures favouring each of them can have a repercussion on the total value of the company, which must be taken into account. Our findings demonstrate a greater loss of equity value for insolvent firms under creditor-oriented systems (such as Germany before the reform and the UK), while the valuation is less nega- tive in countries with legislations whose objective centres on firm survival and debtor protection. 0144-8188/$ – see front matter © 2009 Elsevier Inc. All rights reserved. doi:10.1016/j.irle.2009.02.002