By Andreas Kostøl (Arizona State University – W.P. Carey School of Business; Norges Bank), Morten Grindaker (Norwegian Business School; Norges Bank), and Kasper Roszbach (Norges Bank; University of Groningen)
Andreas KostølMorten GrindakerKasper Roszbach
Policymakers have long been concerned about the potential negative effects of bankruptcy for CEOs and business dynamics. Fear of reputational scarring caused by bankruptcy could lead managers to take less risk than desired by owners, which could manifest in lower performance and lower rates of entrepreneurship and job growth.
CEOs influence a wide range of decisions, such as organizational practices, debt financing and whether to file for corporate bankruptcy or not. Empirical studies of Chapter 11 bankruptcy show that CEOs of large bankrupt firms suffer significant financial losses. The prospect of individually-borne income loss due to a corporate bankruptcy carries in it a risk that CEOs take decisions that are not aligned with the interest of the owners.
It remains an open empirical question, however, whether the observed personal costs should be attributed to the selection of CEOs with lower managerial skills, firm-specific human capital, or stigma in the executive labor market.
Our analysis attempts to answer this question by disentangling the stigma and skill effects by examining the causal effects of corporate bankruptcy on the personal income and career of CEOs in small and medium-sized companies in Norway. To this end, we exploit that bankruptcy petitions in Norway are randomly assigned to judges who have different degrees of strictness in their approval of bankruptcy filings. This institutional feature generates variation in firms’ likelihood of being declared bankrupt that is unrelated to firm or CEO characteristics. We use administrative panel data that identifies CEO’s sources of wealth and income and corporate positions to examine the effects of bankruptcy on their careers.
Two broad conclusions emerge from our empirical analysis.
First, we find that corporate bankruptcy has a long-lasting impact on CEOs’ careers. CEOs whose firms are declared bankrupt are 25 percentage points more likely to exit the executive workforce. Displaced CEOs find new employment quickly but do so by moving to lower-ranked positions in new firms. Bankruptcy also has an economically significant impact on CEO remuneration; we document an annual fall in capital income equal to about five percent of annual gross income. While the net present value of the average decline in capital income over the remainder of a CEO’s working-age career is equal to 60 percent of pre-bankruptcy annual income, we find no enduring effect on CEOs’ labor income after five years.
Second, our analysis shows that the displacement effects are much larger when default rates in the firms’ industry are low. For example, a CEOs is five times less likely to remain in the executive workforce if her/his firm experiences a bankruptcy while the bankruptcy frequency in the same industry is low. By contrast, variation in CEO wages is not driven by industry conditions. Post-bankruptcy, we find a greater mobility of CEOs between industries and an increased tendency to move to more productive firms with a higher-paid workforce, suggesting that managerial skills are portable.
Taken together, our findings suggest that negative career effects of bankruptcy can be attributed to stigma. When we eliminate the risk of low-skilled CEOs sorting into bankrupt firms, we find that the executive labor market interprets bankruptcy as a signal of lower managerial talent. This stigma effect is greater during better economic times. More details can be found in the full paper that is available here.
By Diana Bonfim (Banco de Portugal; Catholic University of Portugal – Catolica Lisbon School of Business and Economics) and Gil Nogueira (Bank of Portugal – Research Department)
Diana BonfimGil Nogueira
How does corporate reorganization affect labor outcomes in bankruptcy? The existing literature argues that corporate reorganization affects the reallocation of labor because it retains workers in bankrupt firms. In some cases, bankrupt firms remain alive for too long and retain workers inefficiently. In other cases, reorganization reduces the probability of inefficient liquidation.
In this paper we show that resource retention is not the only determinant of labor outcomes in bankruptcy. The decision process in bankruptcy creates a principal-agent problem between firms’ claimholders and other stakeholders (e.g., workers, suppliers). Claimholders decide bankruptcy outcomes but other stakeholders with limited say in the bankruptcy process are also affected by these outcomes.
Workers are among these stakeholders. They use job contracts with firms as a form of insurance in times of adversity. In the absence of corporate reorganization, workers lose these job contracts and experience persistent costs of job loss. Reorganization improves labor outcomes because it reduces the probability that workers lose the insurance provided by job contracts when the costs of job loss are high.
We test this hypothesis empirically using data from Portuguese reorganization cases. The institutional setting has several features that help design an adequate empirical strategy. First, reorganization cases are randomly allocated across judges. We use this random assignment as a source of variation in the probability of reorganization that is not affected by other factors that also influence workers’ careers. Second, Portuguese firms report financial statements annually, which we use to check whether reorganization affects labor reallocation to more productive or profitable firms. Finally, we link this data to a rich administrative employer-employee matched dataset, which allows us to track workers who eventually change jobs. This dataset is unique because it contains rich job descriptors. We use this data to establish a relationship between corporate reorganization and the scarring effect of bankruptcy on workers’ job functions.
We uncover three main findings. First, we measure the effect of corporate reorganization on the sorting of workers to productive and profitable firms. In five years, only about 20% of the workforce remains in reorganized firms. Many workers from reorganized firms find jobs with new employers. We find no evidence that reorganization affects the reallocation of labor to efficient or profitable firms.
Second, reorganization is an important source of labor insurance against negative productions shocks. In the short term, reorganization increases the probability that workers are employed. In the long term, reorganization increases wages and reduces the scarring effect of job downgrading that is often observed in recessions. Reorganization reduces the probability that workers move to less skill-intensive occupations and increases occupation wage premia.
Third, we show that reorganization improves job transitions to new employers. Reorganization increases the average time it takes to leave a firm that files for bankruptcy by one year. Reorganization reduces the probability that workers move to low-paying jobs and increases the probability that workers find high-paying jobs with new employers.
Overall, our results show that corporate reorganization is an important source of labor insurance in bankruptcy, thereby mitigating the scarring effect of job loss. The full article is available here.
By Benjamin Charles Iverson (Brigham Young University), Joshua Madsen (University of Minnesota, Twin Cities, Carlson School of Management), Wei Wang (Queen’s School of Business), and Qiping Xu (University of Notre Dame, Department of Finance).
Prior studies document the influence of bankruptcy judges’ discretion on restructuring outcomes, yet we know little about how judicial experience affects the bankruptcy process. We study how the accumulation of job-specific human capital influences judges’ efficiency in handling large corporate bankruptcy filings, using 1,310 Chapter 11 filings by large U.S. public firms overseen by 309 unique bankruptcy judges in 75 bankruptcy courts between 1980 and 2012.
Using random assignment of judges to cases for empirical identification, we show that cases assigned to a judge with twice as much time on the bench realize a 5.5% decrease in time spent in reorganization. This reduced time in court translates into savings of approximately $2 million in legal fees alone for a typical case in our sample. Judges’ time on the bench is associated with higher probability of emergence but not higher recidivism. The combined evidence suggests that more experienced judges are overall more efficient. We also find that it takes up to four years for a new judge to become efficient and that judges who see a higher volume of business filings and a greater diversity of cases by size and industry early in their tenure become efficient faster than those who don’t. We find little evidence that judges’ general experience and personal attributes consistently affect case outcomes.
Our analyses highlight a potential benefit of allowing firms to file in courts with more experienced judges. Restricting this flexibility (e.g., through the proposed Bankruptcy Venue Reform Act of 2017) may impose a cost on firms by forcing them to file in courts with less experienced judges.
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.
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.
Author: Edward I. Altman, NYU Stern School of Business
This 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.
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.
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.
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.
This 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.