Self-Fulfilling Prophecies of Failure: The Endogenous Balance Sheets of Distressed Companies


  • G. Meeks ( is a Professor of Financial Accounting in the Judge Business School, University of Cambridge, and J. G. Meeks a Fellow of Robinson College, University of Cambridge.

  • We are very grateful to the Leverhulme Trust for financial support; to the U.K. Business Statistics Office for providing financial statement data; to Joyce Wheeler for computing assistance, and Bruce Weisse for research assistance; to Harvard Business School and INSEAD for providing facilities to carry out parts of this research; to insolvency practitioners, auditors and credit insurers for valuable interviews; and to John Armour, Robin Chatterjee, David Citron, Graeme Dean, Riz Mokal, Todd Pulvino, Len Sealy, Simon Taylor, Geoffrey Whittington, an anonymous referee, and seminar participants in Economics and Law at the University of Cambridge and at the British Accounting Association Annual Congress for stimulating discussions and suggestions.

  • The financial statement data used in the appendix are available from the ESRC Data Archive, University of Essex.


This article analyses a problem at the intersection of accounting, law, and economics: the economically efficient operation of legal arrangements for company failure is undermined because valuations of assets and liabilities become unstable once a firm is distressed. The paper draws on the three disciplines to show the pivotal role of asset and liability valuations in answering the legal question, whether the firm is insolvent, and the economic question, whether the firm should fail and its assets be redeployed to an alternative use. U.S. and U.K. evidence reveals a disconcerting indeterminacy in these processes: the probability that a firm will fail affects significantly the valuations assigned to assets and liabilities; but at the same time the valuation of assets and liabilities itself determines the probability of failure. This balance sheet endogeneity is then shown to delay economically efficient management changes under debtor-oriented U.S. Chapter 11, and to induce unnecessary costly bankruptcy with creditor-oriented U.K. receivership/administration. Recent cases trace this endogeneity in failures involving often controversial countermanding of huge financial claims.