Corporate bankruptcies constitute an important mechanism for the economy to purge itself of obsolete firms and allocate their constituent parts to more productive uses. This process of reallocation of human and physical capital is an ‘essential fact about capitalism’ (Joseph A Schumpeter, Capitalism, Socialism and Democracy (1st edn, Routledge 1942)).
While resources may on average be used more productively following a bankruptcy, this process is not deterministic and likely involves various imperfections. In particular, in addition to the potential loss in value to the firm’s re-deployable physical capital stock (for example, due to asset fire-sales), bankruptcy may involve some deterioration of organizational and human capital. Moreover, frictions in the post-bankruptcy re-allocation of resources across firms may lead capital and labor to be idle for some time or even result in protracted sub-optimal uses. In the case of workers, unemployment spells could also accelerate the depreciation of skills.
An important dimension of human capital that may be affected by bankruptcy is human capital that is specific to teams; we refer to this as ‘team-specific human capital’. This kind of human capital, which is embedded in collaborative relationships, allows groups of workers to combine their efforts efficiently in the production of a joint output. Understanding whether team-specific human capital is efficiently reallocated during bankruptcies is important because teamwork has become a common way of organizing production in modern firms, in particular when complex tasks are involved.
In a recent paper, we analyze the career and productivity of workers around corporate bankruptcies, and the role that team-specific human capital plays in this context. The focus of our study is corporate innovation, a setting with high-skill professionals and in which team production is important. We employ micro-level data on individual inventors in the U.S. for the period from 1980–2010. Our setting permits us to follow individual inventors across firms and over time, and to measure their individual productivity, both in terms of quantity (patent counts) and quality (citation-based and dollar-based innovation measures).
Our main findings are threefold. First, corporate bankruptcies are associated with a disruption in team stability, which leads to a loss of team-specific human capital. Therefore, inventors that tend to work in teams — those that have co-authored a significant share of patents with other inventors in the financially distressed firm — experience more negative effects on their productivity post-bankruptcy than inventors that rely less on team production.
Second, we find that both the labor market and the market for corporate control appear to value team-specific human capital and encourage its preservation after bankruptcy. Specifically, inventors that tend to work in teams before the bankruptcy are more likely to co-locate with their team members post-bankruptcy. This is especially the case for those inventors that have collaborated in the production of particularly valuable innovation. Moreover, firms where production is more dependent on teamwork before the bankruptcy are more likely to be acquired (in whole or part) during bankruptcy, perhaps because doing so facilitates the preservation of human capital that is specific to teams.
Third, we find that inventors that co-locate with their team members after the bankruptcy innovate more, both compared to before the bankruptcy and relative to inventors that do not end up working at the same firm as their teammates. This increase in productivity may arise because teams that are more successful tend to survive. It is also conceivable that the new employer is less financially constrained and can direct more resources to the team than the previous employer.
Our results paint a nuanced picture of the reallocation of human capital through bankruptcy. Team dissolution increases around bankruptcy and team inventors become less productive than their less team-dependent colleagues. However, the labor market and the market for corporate control promote the preservation of team-specific human capital. Therefore, on balance, the productivity losses associated with bankruptcy are modest for team-dependent inventors. In addition, inventors who do not work in teams even seem to experience an increase in their post-bankruptcy productivity (although these effects have limited statistical significance). Overall, we conclude that frictions that limit the efficiency of asset reallocation through bankruptcy may be limited in the case of highly skilled labor.
Ramin Baghai is an Associate Professor at the Department of Finance of the Stockholm School of Economics.
Rui C. Silva is an Assistant Professor of Finance at the London Business School.
Luofu Ye is a researcher at the London Business School.