Selling Innovation in Bankruptcy

posted in: 363 Sale, Valuation | 0

By Song Ma (Yale School of Management), (Joy) Tianjiao Tong (Duke University, Fuqua School of Business), and Wei Wang (Queen’s School of Business).

The past decades have witnessed the emergence of patent sales in corporate bankruptcies. Yet we know little about the facts and rationales of these important economic transactions.

In this working paper, we assemble a comprehensive data set of US Chapter 11 filings, USPTO patent transaction documents, and court records on assets sales from the past three decades. We document three stylized facts on patent sales in bankruptcy. First, patent sales are pervasive — more than 40% of bankrupt firms sell at least one patent, and on average they sell 18% of their patent portfolios. Second, patent transactions occur immediately after bankruptcy filing — concentrating largely within the first two quarters after filing. Third, patents are frontloaded in general asset sales in bankruptcy — firms sell a disproportionately large quantity of patents in asset sales during the early period of reorganization.

Why do firms sell patents during bankruptcy? We design a set of empirical tests to study the economic decisions behind patent sales based on the two economic views on assets reallocation in bankruptcy, namely asset restructuring and financing through asset sales. Our results show that bankrupt firms reallocate patents that are more redeployable and trade in a more liquid market . We find no evidence that they sell underexploited or underperforming patents. This pattern of selling more liquid patents holds stronger in firms with financial distress, firms undergoing poor industry conditions, and firms lacking external financing. The combined evidence lends support to the view that firms sell innovation during bankruptcy for financing purposes rather than for asset restructuring. Additionally, we find that bankrupt firms try to retain the inventors of sold patents and continue to cite sold patents after their sale. The evidence overall suggests that a firm’s imminent financing needs interact with its intent to avoid bankruptcy costs in shaping a firm’s decision to sell patents in bankruptcy.

The full paper is available here.

 

The Roundtable will be off for the holidays. We’ll be back early after the New Year.

Fiduciary Duties in Bankruptcy and Insolvency

By John A. E. Pottow (University of Michigan Law School).

Although discussed nowhere in the U.S. Bankruptcy Code, fiduciary duties play a central role in guiding the administration of an insolvent debtor’s assets. Regulatory oversight of trustees is only loosely circumscribed by statute, but significant lacunae exist regarding specification of the duties of loyalty.  In assessing what fiduciary obligations are owed to secured creditors, unsecured creditors, and debtors, some courts build upon the general principle that the trustee’s fiduciary duty of loyalty flows to all creditors. Other courts, though, work from the premise that secured creditors are better situated to look after themselves and that a trustee’s primary obligation is to unsecured creditors, perhaps especially non-priority general creditors. The Supreme Court has also weighed in, stating that a DIP’s fiduciary duties run directly (if somewhat delphically) to “the corporation.” How then does a trustee choose between beneficiaries of the estate, and what remedies are there for losing parties disappointed with this allegiance decision?  This book chapter explores the fiduciary obligations of trustees (including DIPs) under both statute and common law. There is a special focus on the intrinsic conflicts that arise within the “menagerie of heterogeneous creditors” that constitute the claimants of a bankruptcy estate.  A single normative theory seems unlikely to explain the results (so much for the “residual fiduciary beneficiary”!).  What does seem clear is that trustees are “more fiduciary” for some constituencies than for others.  Fortunately, U.S. bankruptcy courts are accustomed to shifting allegiances and disalignments of interest. Thus, the bankruptcy system may be well-suited to handle the endemic conflicts of interest between corporate constituencies through various bankruptcy-specific mechanisms, such as the institution of the Creditors Committee and the norm of engaged judicial oversight.

The full article is available here.

Optimal Capital Structure and Bankruptcy Choice: Dynamic Bargaining vs. Liquidation

posted in: Valuation | 0

By Samuel Antill and Steven R. Grenadier (Stanford Graduate School of Business)

In this work, we develop and solve a continuous-time dynamic bargaining model of Chapter 11 reorganization. We include many features of the Chapter 11 process, such as the automatic stay, suspension of dividends, the exclusivity period, post-exclusivity proposals by creditors, and the potential for forced conversion to Chapter 7. The reorganized firm may issue new debt and continue operating. Moreover, both debtors and creditors face uncertainty over future asset values as they debate reorganization plans. We solve for the equilibrium and the corresponding expected payoffs to creditors and equityholders.

Using this equilibrium, we proceed to model a firm’s optimal capital structure decision in a framework in which the firm may later choose to enter either Chapter 11 reorganization or Chapter 7 liquidation. Creditors anticipate equityholders’ future reorganization incentives and price them into credit spreads when the debt is issued (ex ante). The implied capital structure results in both higher credit spreads and dramatically lower leverage than existing models suggest. Giving creditors more bargaining power in bankruptcy typically leads to higher leverage and ex ante firm value, consistent with empirical evidence. If reorganization is less efficient than liquidation, the added option of reorganization can actually make equityholders worse off ex ante, even if the firm is eventually liquidated.

The full article is available here.