Spillovers from Financial Distress and Bankruptcy: Evidence and Implications for the Real Economy

Abstract

Bankruptcy reallocates assets, labor, and risk across firms and households, yet its consequences extend far beyond the firms and households directly involved. This article reviews empirical and theoretical advances on spillovers from financial distress and bankruptcy—the transmission of financial distress through labor markets, product markets, supply chains, financial networks, and social interactions. We bring together evidence on how corporate bankruptcy affects workers, competitors, suppliers, and local economies, and how these effects aggregate to influence economic outcomes more broadly. We also highlight emerging evidence on consumer bankruptcy spillovers within peer and family networks. The literature consistently shows that these spillovers are substantial and operate through multiple channels. Throughout, we identify open questions about their welfare implications, the design of optimal bankruptcy policy, and opportunities to better characterize spillovers that have not yet been explored.