… if it is clear that even debt holders will not get their money, then share price should drop to zero, otherwise, there are risk takers who will stick their heads knowing it would only cost them a few bucks to buy the entire company. In your case, Braniff may have been in deep mess that no one wanted to buy its shares at anything over zero dollars. Just my guess.
First, it doesn’t work that way. Equity is a residual interest in the company. A call on assets with strike = value of the debt. There can be plenty of money to pay lots of debtholders and still have the equity go to 0. At the extreme end secured bank debt averages recoveries of like 90% in bankruptcies. There may be reasons to pay a little for equity in bankruptcies but not many very compelling ones. Second, there is no reason I know of that you have to cover just because the stock went down to near 0 or 0. I can’t say that I have ever had the experience of being short a stock that goes to 0, but I’m ready. Braniff just dried up and went away. I think there is some residual company that manages the pension plan now but the equity value was just wiped away.
Braniff is making a comeback as a high fiber cereal.
The only thing that doesn’t make sense is that I would think the stock holders would eventually sell to take the tax loss and you’d have to cover, but having never been in the situation I’ll defer to VCFA.
Naked, There are some companies that languish in the penny ranges for a long time. I’m not sure what the deal is with those. But, a big bk, like with enron or braniff, then usually the regular equity gets wiped pretty quick and new equity is issued to the bond holders. Before the gavel hits you will see the old equity flopping around quit a bit from 80 cents down to 40 cents up to $1.20, etc. They could even be in BK proceedings at that point in time. Then, all of sudden, it will just disappear. Soon a new equity will appear that the bond holders all own.
I’m not much of an expert on this, but here’s more or less how this works. In a normal US Chapter 11 filing, management has 120 days to submit a reorganization plan. If the company is truly insolvent, management will probably lose any equity interests they personally have and likely lose their jobs. That means that management has incentives to delay the reorganization filing, convince the Court that the company is truly solvent and worth as much money as possible, and that old equity is still valuable. It’s usually fiction and it’s asking a judge to evaluate some very difficult financial analysis while people are lying to him. That means anything can happen and owning equity in this spot is a bet that management will get a reorganization plan approved that lets the existing equity survive (it happens). I’ve heard of delays in the several years category for submitting a reorganization plan and, as with most court things, you can delay for a long time. During this time, you never know if Chairman Jed is going to be shooting up some food, when up from… Anyway, that’s why the equity languishes in the pennies range for awhile. In the normal course of things, particularly with visible bankruptcies like Braniff (which was darn close to a Chapter 7 filing - they fired pilots who were in the middle of flying their routes - yikes) and Enron (management was quickly more concerned with staying out of jail than maintaining their jobs and equity interests) the old equity is just cancelled and new equity may be issued to creditors if the company is a going concern. If you’re short the old equity and it’s cancelled, you owe nobody anything. I’d like to know how the procedure goes with your broker but presumably any margin balance restricted by that short sale is now unrestricted. And I guess that there is no taxable event there or at least I couldn’t find one in my search of the tax code (absolutely do not rely on my opinion of that for anything that matters). The interesting thing is that if you bet on Braniff or similar to go under using any derivative that I can think of, there is some taxable event there usually at the derivative expiration date or at some credit event like the bankruptcy filing. That’s a pretty interesting mismatch, I think.
In the UK the revenue holds a list of “holdings of negligible value”. Once the equity is on this list, if you are long you can claim a disposal at your leisure without actually selling. I’m not sure what happens when you are short - I’d assume the same disposal rules apply. Interesting one.