We investigate how institutional factors influence behavior of distressed firms in emerging markets, where bankruptcy laws are often weak and debtors have greater bargaining power in distress. By studying a comprehensive sample of distressed firms in China, a representative of the cases in other emerging markets, we find that institutional background matters considerably to distress resolution. Distressed companies facing better institutional background (i.e. with less state ownership structure, in regions with better government quality and greater degree of local financial development), display relatively better operating performance, more disciplined capital structure, and higher ultimate recovery likelihood. Our findings provide novel evidence on how institutional factors discipline distressed firm behavior and facilitate distress resolution in emerging markets.