Many firms in the United States file for bankruptcy every year, yet they still continue operating. Why would they do this instead of completely shutting down?
In the United States, bankruptcy is governed by federal law. The state laws are often applied to determine how bankruptcy affects the property rights of debtors. However, there's a threshold. Bankruptcy cases are usually either voluntary or involuntary. Involuntary bankruptcy, which is the majority of cases, debtors petition the bankruptcy court. With involuntary bankruptcy, creditors file the petition in bankruptcy. The bankruptcy system generally tries to reward creditors who continue to extend financing to debtors and discourage creditors from accelerating their debt collection efforts. Avoidance actions are some of the most obvious of the mechanisms to encourage this goal.
Although they file for bankruptcy, and they possibly have to shut down in the end, they still continue operating. Why? Recall the profit-maximize firms are increasing their production until their marginal cost equals the marginal revenue, which doesn't make sense to produce one more to lose more money, and we can split the average total cost into two parts, the fixed cost, and the variable cost. The reason why they still stay in the market and continue operating is their operations can cover some fixed costs since the revenues are higher than the variable cost. If the price, the marginal revenue is higher than the variable cost, it means their operations actually help them to pay for some of their fixed cost.
Suppose the Starbruce Bank is operating in the negotiation of bankruptcy. It earns $1,000,000 in revenue but has to pay $5,000,000 for fixed cost, and $200,000 for variable cost. So, the profit is $-4,200,000. If the Starbruce chooses to shut down, their revenue is zero, but still has to pay the $5,000,000 for the fixed cost. Compare those two options, you may find that continue operating is a relatively better choice.
Now we know the reason. Firms in the United States continue operating after filing for bankruptcy become it's less costly to file for bankruptcy and continue operating than to shut down because there are costs to shutting down and to resume business operations.
Imagine that you are managing a small firm and thinking about entering the market of a monopolist. The monopolist is currently charging a high price, and you have calculated that you can make a nice profit charging 10% less than the monopolist. Before you go ahead and challenge the monopolist, what possibility should you consider for how the monopolist might react?
While the oil price rises in earlier years, America’s shale oil industry entering the market of a near-monopoly market which almost being controlled by the OPEC. They clearly need to consider how the monopolist might react. The OPEC reacted with predatory pricing, which uses the threat of sharp price cuts to discourage competition. In the beginning, the OPEC wants to reduce the marginal revenue generated by America’s shale oil industry to make them unprofitable, since they can produce at a very low price.
Similarly, if I managing a small firm and thinking about entering the market of a monopolist, I would have to consider the predatory pricing the monopolist might react. And I also need to consider the roots of the monopoly, was it natural, control of a physical resource, legal monopoly, patent, or just intimidating potential competitors like the OPEC. Before setting the strategies to entry, I better know how it monopoly or what is the monopolist.
Reference
https://en.wikipedia.org/wiki/Bankruptcy_in_the_United_States
Putin dumps OPEC to start a war with America's shale oil industry. (n.d.). Retrieved from https://www.worldoil.com/news/2020/3/6/putin-dumps-opec-to-start-a-war-with-america-s-shale-oil-industry
McFarlane, S., & Minczeski, P. (2019, April 18). OPEC vs. Shale: the Battle for Oil Price Supremacy. Retrieved from https://www.wsj.com/articles/opec-vs-shale-the-battle-for-oil-price-supremacy-11555588826
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