Creditor Conflict and the Efficiency of Corporate Reorganization

posted in: Cramdown and Priority | 0

By Mark Jenkins at University of Pennsylvania and David C. Smith at University of Virginia

While a rich set of theories make clear that incentive conflicts between senior and junior claimants in a company’s capital structure may lead to inefficient outcomes, empirical evidence on how often these conflicts do so has been limited. In this paper, we study the incentives of senior claimants to force inefficient liquidations, or liquidations in which a firm’s assets are sold for less than the firm’s value as a going concern. We develop a bargaining model that assumes senior creditors can exert strong control over whether a firm reorganizes or liquidates during the bankruptcy process. The estimable parameters of the model allow us to gauge the efficiency of bankruptcy outcomes using a large sample of U.S. corporate bankruptcy cases over the period 1989 to 2011.

The main result of the paper is an estimate of the value loss that results from inefficient liquidations in bankruptcy. We estimate these losses to be up to 0.28 percent of the going-concern value of the firm, on average, across all bankrupt firms in our sample. As predicted by theory, these losses are realized primarily by firms with asset values that are close to the face value of secured debt. Our estimate of efficiency losses is driven by several auxiliary findings, including estimates of the fraction of firms that are efficiently reorganized, the fraction of firms that are efficiently and inefficiently liquidated, and the average liquidation discount faced by firms in bankruptcy.

The full article can be found here.

Revisiting the Recidivism-Chapter 22 Phenomenon in the U.S. Bankruptcy System

Author: Edward I. Altman, NYU Stern School of Business

Altman bio picThis study finds that about 15% of all debtors, who emerge as continuing entities from reorganization under Chapter 11 bankruptcy, or are acquired as part of the bankruptcy process, ultimately file for bankruptcy protection again. This recidivism rate spikes to 18.25% when considering only those firms which emerge as a continuing, independent entity. This highlights what appears to be a significant recidivism problem of our Chapter 11 system.

This article argues that the so-called “Chapter 22” issue should not be dismissed by the bankruptcy community as acceptable just because no interested party objected to the plan of reorganization during the confirmation hearing. Indeed, by applying the Z-Score model to large samples of Chapter 11 and Chapters 22, 33, and 44 firms, highly different and significant expected survival profiles are shown at the time of emergence. The bond-rating-equivalent of the multi-filing sample was CCC versus a BB-profile for the single-filing Chapter 11 sample. I believe that credible distress prediction techniques can be important indicators of the future success of firms emerging from bankruptcy and could even be used by the bankruptcy court in assessing the feasibility of the plan of reorganization – a responsibility that is embedded in the Bankruptcy Code.

The full article is available here.

 

Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts

By Benjamin Iverson, Kellogg School of Management at Northwestern University

On average, total bankruptcy filings rise by 32% during economic recessions, leaving bankruptcy judges with far less time per case exactly when financial distress is worst.  The inflexible nature of the bankruptcy system coupled with the varying demands placed upon it, leads to the concern that time constraints might limit the effectiveness of bankruptcy when economic conditions deteriorate.

In my paper, “Get in Line: Chapter 11 Restructuring in Crowded Bankruptcy Courts,” I test whether Chapter 11 restructuring outcomes are affected by time constraints in busy bankruptcy courts.  Using the passage of the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005 as a shock that decreased caseloads dramatically, I show that as bankruptcy judges become busier they tend to allow more firms to reorganize and liquidate fewer firms.  I interpret this as evidence that busy bankruptcy judges defer to the debtor in possession more often, scrutinizing each case less and thereby allowing reorganization more often.  In addition, I find that firms that reorganize in busy courts tend to spend longer in bankruptcy, while firms that are dismissed from busy courts are more likely to re-file for bankruptcy within three years of their original filing.

Perhaps most striking, I also show that busy courts impose costs on local banks, which report higher charge-offs on business lending when caseload increases.  If time constraints create higher costs of financial distress, it appears that these costs are typically passed on to the creditors of the bankrupt firms in the form of higher losses on distressed loans.

The full-length article can be found here.

 

Activist Investors, Distressed Companies, and Value Uncertainty

posted in: Claims Trading | 0

Authors:  Michelle M. Harner, Jamie Marincic Griffin, and Jennifer Ivey-Crickenberger

Hedge funds and other private investment funds often play a key role in chapter 11 cases.  They may hold the debtor’s prepetition secured debt or provide postpetition financing to the debtor.  They also may buy and trade the debtor’s secured and unsecured debt both before and after a chapter 11 filing.  These activities can provide much-needed liquidity to a debtor and foster a robust secondary market for creditors looking to exit the credit.  A fund’s participation in a case, however, sometimes generates litigation and, arguably, both delays the resolution and increases the cost of the case.  Consequently, many commentators and practitioners debate the utility of funds in restructurings.

In our most recent article on funds in chapter 11, we conduct an original empirical study of funds as purchasers of chapter 11 debtors.  Specifically, the study analyzes cases where a fund (individually or as part of a group) acquires control of a debtor through the chapter 11 process by purchasing either substantially all of the debtor’s assets or a majority interest in the reorganized stock.  In the stock acquisition context, we were concerned only with the investment of new capital.

Overall, the data suggest that funds have the potential to provide value in chapter 11.  But neither the participation of funds nor the chapter 11 process itself is a panacea, and more empirical and traditional case studies are needed to understand fully the impact of funds on corporate restructurings.  We hope our study encourages further research.

The full-length article can be found here.

The Ownership and Trading of Debt Claims in Chapter 11 Restructurings

posted in: Claims Trading | 0

By Victoria Ivashina, Ben Iverson, and David C. Smith

The role that active investors play in Chapter 11 reorganization is hotly debated in bankruptcy circles. In our paper, “The Ownership and Trading of Debt Claims in Chapter 11 Restructurings,” we collect comprehensive data on individual claims for 136 large firms that filed for Chapter 11 protection to empirically test how active investors might influence the bankruptcy process. Our data allows us to observe the identities of over 77,000 claimants and precisely measure both ownership concentration as well as claims trading for these cases.

We find evidence that firms with more concentrated capital structures are more likely to enter bankruptcy with pre-negotiated or pre-packaged bankruptcy plans, suggesting that negotiations are easier when creditors are not dispersed. In addition, even if they do not have a pre-packaged plan, firms with more concentrated ownership tend to exit bankruptcy more quickly and are more likely to emerge from Ch. 11 intact rather than being sold or liquidated piecemeal.

In the second half of the paper, we turn to the question of how claims trading in bankruptcy affects the resolution of the case. We find that trading during bankruptcy tends to concentrate ownership even further, and that the bulk of claims purchasing is done by hedge funds and other active investors. Interestingly, as these active investors enter the capital structure the overall recovery rate for the case tends to decrease, suggesting that perhaps active investors shrink the size of the overall “pie” in their efforts to obtain a larger piece of it.

The full-length article can be found here.