61 p. ; Includes bibliographical references (pp. 33-37). ; "October 2015." ; The authors wish to thank Ashwini Agrawal (discussant), Jonathan Berk, Rob Fairlie, Todd Gormley, Joseph Hotz, Pab Jotikasthira (discussant), Andrew Karolyi, Bryant Kim, David Matsa, Roni Michaely, Paige Ouimet (discussant), Karin Thorburn (discussant), Michael Waldman, Wei Wang (discussant), Liu Yang (discussant), Hayong Yun, and seminar and conference participants at AFA, Census Bureau RDC Conference, CICF, CSEF-EIEF-SITE Conference on Finance and Labor, Cornell University, EFA, FIRS conference, IDC Summer Finance Conference, SFS Finance Cavalcade, SOLE/EALE, and University of Calgary for helpful feedback. We also thank Bert Grider at the Triangle CRDC for help with data and clearance requests, and Cindy Lu for research assistance. Any opinions and conclusions expressed herein are those of the author and do not necessarily represent the views of the U.S. Census Bureau. All results have been reviewed to ensure that no confidential information is disclosed. This research uses data from the Census Bureau's Longitudinal Employer Household Dynamics Program, which was partially supported by the following National Science Foundation Grants SES-9978093, SES-0339191 and ITR-0427889; National Institute on Aging Grant AG018854; and grants from the Alfred P. Sloan Foundation. We are grateful to Lynn LoPucki of UCLA for sharing his Bankruptcy Research Database. Kim acknowledges generous financial support from the Kwanjeong Educational Foundation. Li and Qiu acknowledge financial support from the Social Sciences and Humanities Research Council of Canada. This paper was previously circulated under the title “Human Capital Loss in Corporate Bankruptcy.”

This paper examines how bankruptcy by a firm leads to costs borne by its employees due to reallocation of the workforce. Using worker-firm matched data from the U.S. Census Bureau’s LEHD program, we demonstrate that annual wages deteriorate by about 10% upon corporate bankruptcy and remain below pre-bankruptcy wages for (at least) six years. In addition, when a firm files for bankruptcy, its employees are significantly more likely to work fewer hours, leave the firm, leave the industry, and leave the local labor market, relative to employees of solvent firms with similar characteristics. Wage losses are larger for individuals who leave the firm, the industry, and the local labor market, and for those in “thinner” local labor markets. We show that the ex-ante wage premium that firms must pay to compensate for the expected wage loss due to bankruptcy is up to half of the magnitude of the tax benefits of debt. This result suggests that indirect bankruptcy costs due to workforce reallocation are of a magnitude to be a first-order consideration for firms as they make capital structure choices. Valuation Insight: Graham, Kim, Li, and Qiu argue that important destruction of value takes place in the process of bankruptcy. Wages of the employees of bankrupted firms decrease significantly. As a result, firms with considerable bankruptcy probabilities must offer substantial wage premiums upfront to hire and retain individuals. Hence, firm value would benefit from a more secure capital structure.