Indore (Madhya Pradesh): A new study by the Indian Institute of Management (IIM)-Indore has found that corporate bankruptcies can have far-reaching consequences beyond the failed firms themselves -- potentially destabilising even financially healthy companies within the same industry.
Published in the reputed journal ‘Finance Research Letters’, the study titled ‘Bankruptcy Spillovers and Stock Price Crash Risk of Non-Bankrupt Firms’ is co-authored by Prof Radha Mukesh Ladkani of IIM-Indore. It highlights that each additional bankruptcy filing within an industry can increase the likelihood of a stock price crash for non-bankrupt peers by 21 per cent.
The research, which analyses data from listed Indian firms between 2010 and 2021, suggests that waves of bankruptcies create ripple effects through investor sentiment, credit markets and managerial decision-making. As borrowing costs rise and credit access tightens, managers often delay revealing bad news to protect their reputation or stabilise short-term performance. When this suppressed information eventually surfaces, the market reaction is typically sharp and severe-- manifesting as a stock price crash.
“The study shows that bankruptcy contagion doesn’t stop at the failing firms-- it spills over to others in the ecosystem, influencing investor confidence and management behaviour,” said Ladkani.
A key contribution of the study is introducing Stock Price Crash Risk (SPCR) as a new channel through which bankruptcy spillovers operate. Earlier studies largely focused on reduced lending or investment constraints, but this research connects the dots to capital market volatility and systemic risk.
Importantly, the study has also found that the Insolvency and Bankruptcy Code (IBC) introduced in 2016 played a stabilising role. During the IBC period (2017–2021), the crash risk among non-bankrupt firms declined significantly. Stronger creditor rights and faster resolution processes under the IBC improved credit access and encouraged managers to disclose bad news promptly, thereby reducing abrupt market shocks.
Firms already facing financial constraints were found to be more vulnerable to these spillover effects, while financially robust firms showed greater resilience. The study’s conclusions were further reinforced through tests ruling out broader economic downturns or crises like the Covid -19 pandemic as alternate explanations.
The findings carry vital lessons for regulators, investors and corporate leaders. Industry-level financial distress, the researchers argue, must be treated as a collective risk rather than an isolated event.
Strengthening insolvency frameworks and encouraging transparency can prevent cascading failures and enhance market stability.
By uncovering the link between bankruptcy clusters and stock market fragility, IIM-Indore’s study offers an important perspective on how policy reforms can build resilience in emerging economies.
