With high-profile company bankruptcies becoming a distressingly common occurrence, many would be hard-pressed to find an upside in the situation.

According to a new study by three finance researchers at the University of Utah's David Eccles School of Business, however, there might be a silver lining of sorts: the effectiveness of the U.S. bankruptcy system.

They found that 80 percent of fundamentally sound companies—those with good business models but too much debt—reorganized and emerged from Chapter 11 with only 7 percent fewer assets. Chapter 11 allows reorganization rather than liquidation.

On the other hand, just 37 percent of economically distressed companies—those with severe business problems such as poor management, outdated technology, or flawed business models—reorganized successfully. Additionally, they emerged as considerably smaller companies, retaining on average less than 50 percent of their original assets. The rest of the economically distressed companies were liquidated or purchased by others.

In addition, all reorganized firms had reduced debt by 50 percent by the time they emerged from Chapter 11.

"We found that the bankruptcy system is largely successful at helping fundamentally strong companies recover from financial problems, while dismantling weaker companies whose troubles are more severe," says Elizabeth Tashjian, one of the authors of "Financial and Economic Distress and Restructuring Heterogeneity in Chapter 11."

The study is being published online by the Social Sciences Research Network.

The study reviews data from 530 companies that entered bankruptcy between 1991 and 2004, making it much more comprehensive than previous research on bankruptcy policy, says Tashjian, associate professor of finance at the University of Utah and a member of the Academic Advisory Council of the Turnaround Management Association.

"There's no question that the process isn't perfect, but it seems that Chapter 11 is doing what it's supposed to do," she says. "It seems to take the assets away from those firms that are destroying the value of assets and retain them in firms that have a good chance of surviving and creating value."

The U.S. bankruptcy process is markedly different from that in countries such as Sweden, where companies are sold without getting a chance to restructure, says University of Utah finance Professor Michael Lemmon, who co-authored the study.

"The study doesn't say that the U.S. has the best bankruptcy procedure," he says. "It does say that some of the criticisms that have been levied against U.S. bankruptcy procedure don't appear to be that important."

While previous research has focused on the average outcomes of firms going into Chapter 11, Tashjian says she and fellow researchers tried to approach the subject in a more nuanced fashion, recognizing that firms file for bankruptcy for different reasons.

Companies in the study were divided into two separate groups: "financially distressed," which were fundamentally sound firms with good business models, but too much debt, and "economically distressed," which had poor operating performance for a number of factors, including bad management, outdated technology, or a flawed business model.

"The fundamentally sound companies create value, so ideally, the bankruptcy process would reduce their debt and let them continue," he says. "You don't want to shut down those companies completely."

Because economically distressed companies potentially are harming the value of their assets, Tashjian says an ideal bankruptcy policy would favor selling off unprofitable pieces or liquidating them all together.

Tashjian says she and her colleagues used two simple accounting variables to arrive at their conclusions: operating earnings to assets, with profit margins adjusted by industry, and debt to value: basically, the amount of leverage a company has.

Financially distressed firms tended to have bad debt ratios but good operating performance, Tashjian says.