Abstract

This paper examines the fate of firms that report negative book-value equity leading up to the 2008 Great Recession. This is the first study to document the quantity and longevity of negative equity firms and to analyze the sources of funds used to sustain these failing and recovering firms. For the full sample of Compustat from 1970 to 2007, negative-equity firms account for 9.66% of the 246,869 firm-year observations. The number of firms reporting negative equity steadily increases over the sample period, with less than 1% of the firms reporting negative equity in 1970 to more than 10% in 2007. Upon initially reporting negative equity, these firms remain active on average for an additional 6.18 years. Distressed firms appear to have a remarkable ability to generate substantial funds through short-term and long-term debt and through the issuance of stock, thereby postponing or avoiding costly bankruptcy. While negative equity firms may not have caused the 2008 Great Recession, the findings of this study reveal a disturbing trend that warrants further research.

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