Bankruptcy Reorganization Research Articles

Do Market Prices Improve the Accuracy of Court Valuations in Chapter 11?

This paper shows that public dissemination of trading information for registered corporate bonds reduces valuation errors in Chapter 11 bankruptcy reorganizations by about half, virtually eliminating unintended wealth transfers between claimants and consequent violations of the absolute priority rule. The impact of dissemination is significantly greater where alternative market-based indicators of firm valuation, such as analyst estimates or outside bids for the company's assets are lacking, and significantly lower where hedge funds are among the debtor’s largest unsecured claimants. The results suggest that the transparency of market prices helps improve the distributional efficiency of Chapter 11 bankruptcy and provide support for proposals to increase the availability of market-based signals to aid the valuation process.

Financial distress at Comercial Mexicana, 2008-2011

Synopsis Controladora Comercial Mexicana, a Mexican retailer, had successfully managed the bankruptcy process and was ready to emerge from its problems, primarily caused by speculation and excessive debt, and begin operations anew. Was the restructured Comerci capable of regaining its position as a premier retailer, and more importantly, was the firm capable of repaying the high level of debt that it carried following bankruptcy reorganization? How strong was the reorganized firm? Had Comerci truly left its problems behind in bankruptcy court, or would history repeat itself? How could Comerci raise funds needed for growth – through additional debt? Though asset sales? Research methodology This case was researched using publicly available information, including the company's financial statements, bankruptcy filings, news stories about the bankruptcy and financial data bases (e.g. ISI Emerging Markets, Economática, Capital IQ, etc.) to obtain information about the competitors and from financial analysts. Relevant courses and levels This case is intended for advanced undergraduate or MBA electives in finance. Students should have a basic understanding of valuation and financing before attempting this case. The case could also be used in a corporate finance or banking class to illustrate bankruptcy and credit risk, or could be used in an international business class to illustrate the differences between USA and international bankruptcies.

The High Court Rules that Post-Petition Income Taxes on the Sale of Farm Assets Are Not Discharged Pursuant to Chapter 12 of the Bankruptcy Code

In Hall v. U.S., 132 S. Ct. 1882 (2012), the Supreme Court ruled that federal income tax liabilities due to individual debtors’ sales of farm assets during the pendency of a Chapter 12 bankruptcy reorganization are not subject to collection or discharge in the debtors’ plan. The Court opined that the post-petition income taxes are not unsecured claims under Bankruptcy Code §1222(a)(2)(A) as they were not “incurred by the estate” under Bankruptcy Code §503(b). Under Code §1222(a)(2)(A), a Chapter 12 plan must provide for full payment of all claims entitled to priority under Code §507 unless the claim is owed to a governmental unit arising from the sale of any farm asset used in the debtor’s farming operation, in which case it will be treated as an unsecured claim. Code §507(a)(8) gives priority to certain pre-petition taxes while Code §507(a)(2) gives priority to administrative expenses allowed under Code §503(b). Code §503(b)(1)(B)(i) allows for any tax “incurred by the estate” to be treated as an administrative expense. The Court gave the phrase “incurred by the estate” its plain meaning and applied I.R.C. §§1398 and 1399, reasoning that under I.R.C. the Chapter 12 estate was not a separate taxable entity and that the debtor was individually responsible for the tax. In reaching its decision, the Court viewed the statute’s plain language, context, and structure.

Do managerial behaviors trigger firm exit? The case of hyperactive bidders

Abstract This paper investigates the effects of managerial mergers- and acquisitions-related investment strategies on the exit risk of firms. Using a sample of hyperactive bidders, I show that managerial excessive acquisitiveness can precipitate firm exit. Overbidding is associated with weak corporate governance and lower disclosure quality within firms. I find that hyperactive bidders take more risk compared to conservative bidders. Such bidders also misallocate firms’ resources and dent firms’ reputational capital. Eventually, the external corporate control market is more effective compared to mechanisms such as bankruptcy reorganization, forced liquidation, leveraged buy-out, and expulsion from stock exchanges in disciplining hyperactive bidders by turning them into targets of takeover. These results suggest that a hyper acquisition-induced growth strategy is, on average, detrimental to the long-term survivability of firms and that the internal and external corporate-control mechanisms may not be effective enough to forestall falling value of an excessively acquisitive firm.

Charitable Insolvency and Corporate Governance in Bankruptcy Reorganization

Poor corporate governance is a pervasive problem in the charitable nonprofit sector. Prominent examples of mismanagement and abuse include instances of intentional misconduct, such as embezzlement and unauthorized self-dealing, and negligent conduct, such as failure to diversify the organization’s investment assets. In numerous cases, the lack of good corporate governance had led to the financial distress or failure of a charitable nonprofit firm. A rich literature on nonprofit law has considered the need for better corporate governance and enforcement of fiduciary duties, but the scholarship has yet to address the implications of financial distress and insolvency on corporate governance. This article, ‘Charitable Insolvency and Corporate Governance in Bankruptcy Reorganization,’ fills that void and argues that, when a charity encounters financial distress and approaches the point of insolvency, features and customs of nonprofit and bankruptcy law tend to exacerbate rather than ameliorate the corporate governance problem. Consequently, charitable insiders who breach their fiduciary duties are in a better position to entrench themselves and avoid termination than their for-profit counterparts. In the for-profit sector, three constraints tend to regulate corporate governance by helping to oust fiduciaries responsible for financial distress: bank monitoring of commercial loan covenants; absolute priority and the transfer of ownership in bankruptcy; and involuntary bankruptcy proceedings. In the nonprofit sector, however, those constraints are either less effective or do not apply. As a result, blameworthy charitable fiduciaries are better able to entrench themselves and, without new competent leadership, financially distressed charities are less likely to achieve a full and sustainable financial recovery. My article contains some nascent ideas for reform, including a suggestion that the law might better protect the public interest in charitable assets from waste and abuse by presumptively appointing bankruptcy examiners in all Chapter 11 reorganization proceedings involving substantial charitable assets. Once appointed, bankruptcy examiners would be tasked with identifying the cause of insolvency and individuals responsible for the charity’s financial distress.

The Revision Approach to the Absolute Priority Rule in Chinese Bankruptcy Reorganization Law

The Revision Approach to the Absolute Priority Rule in Chinese Bankruptcy Reorganization Law

Do Managerial Behaviors Trigger Firm Exit? The Case of Hyperactive Bidders

This paper investigates the effects of managerial mergers and acquisitions related investment strategies on the exit risk of firms. Using a sample of hyperactive bidders, I show that managerial excessive acquisitiveness can precipitate firm exit. Overbidding is associated with weak corporate governance and lower disclosure quality within firms. I find that hyperactive bidders take more risk compared to conservative bidders. Such bidders also misallocate firms' resources and dent firms' reputational capital. Eventually, the external corporate control market is more effective compared to mechanisms such as bankruptcy reorganization, forced liquidation, leveraged buy-out, and expulsion from stock exchanges, in disciplining hyperactive bidders by turning them into targets of takeover. These results suggest that a hyper acquisition-induced growth strategy is, on average, detrimental to the long-term survivability of firms and that the internal and external corporate-control mechanisms may not be effective enough to forestall falling value of an excessively acquisitive firm.

Distressed exchange, bargaining power, and prior capital structure

Financially troubled companies often make Distressed Exchange (DE) offers to its creditors, to postpone costly bankruptcy reorganization. We derive the optimal terms and timing of a DE offer consisting of debt reduction and an equity stake in the restructured firm. The DE terms and timing are affected by shareholder bargaining power, with greater shareholder bargaining power resulting in earlier DE offer, smaller debt reduction and smaller equity stake. The impact of shareholder bargaining power is greater when bankruptcy cost is larger and tax rate is higher. We also show that renegotiability of debt increases ex-ante firm value and results in a higher optimal leverage ratio. Both firm value and optimal leverage ratio are decreasing functions of shareholder bargaining power.

An Analysis of the Bankruptcy Reorganization Procedure in China

This paper analyzes the reorganization procedure introduced into the Chinese bankruptcy system in 2007. It shows that managers devote more effort during the reorganization than before the bankruptcy when the emergence value of the bankrupt firm is substantial. In addition, in the pre-bankruptcy period, managers were shown to input less effort under the new law than under the old law. Finally, the paper demonstrates that the market interest rate under the new bankruptcy law is not necessarily lower than that under the old law. These results call attention to the potential costs of the reorganization procedure.

Charitable Insolvency and Corporate Governance in Bankruptcy Reorganization

Poor corporate governance is a pervasive problem in the charitable nonprofit sector. Prominent examples of mismanagement and abuse include instances of intentional misconduct, such as embezzlement and unauthorized self-dealing, and negligent conduct, such as failure to diversify the organization’s investment assets. In numerous cases, the lack of good corporate governance had led to the financial distress or failure of a charitable nonprofit firm. A rich literature on nonprofit law has considered the need for better corporate governance and enforcement of fiduciary duties, but the scholarship has yet to address the implications of financial distress and insolvency on corporate governance. This article, ‘Charitable Insolvency and Corporate Governance in Bankruptcy Reorganization,’ fills that void and argues that, when a charity encounters financial distress and approaches the point of insolvency, features and customs of nonprofit and bankruptcy law tend to exacerbate rather than ameliorate the corporate governance problem. Consequently, charitable insiders who breach their fiduciary duties are in a better position to entrench themselves and avoid termination than their for-profit counterparts. In the for-profit sector, three constraints tend to regulate corporate governance by helping to oust fiduciaries responsible for financial distress: bank monitoring of commercial loan covenants; absolute priority and the transfer of ownership in bankruptcy; and involuntary bankruptcy proceedings. In the nonprofit sector, however, those constraints are either less effective or do not apply. As a result, blameworthy charitable fiduciaries are better able to entrench themselves and, without new competent leadership, financially distressed charities are less likely to achieve a full and sustainable financial recovery. My article contains some nascent ideas for reform, including a suggestion that the law might better protect the public interest in charitable assets from waste and abuse by presumptively appointing bankruptcy examiners in all Chapter 11 reorganization proceedings involving substantial charitable assets. Once appointed, bankruptcy examiners would be tasked with identifying the cause of insolvency and individuals responsible for the charity’s financial distress.

The Warner Archive and DVD Collecting in the New Home Video Market

The Velvet Light Trap, Number 70, Fall 2012 DOI: 10.7560/VLT7004 ©2012 by the University of Texas Press, PO Box 7819, Austin, TX 78713-7819 n November 2010 Metro-Goldwyn-Mayer, once known as the “Tiffany of Studios,” filed for Chapter 11 bankruptcy protection after failing to find a buyer willing to assume its nearly four-billion-dollar debt (Spector). While an investment consortium led by Sony Corporation had purchased the studio for $4.9 billion in 2004, six years later the highest bid received for MGM was $1.5 billion from Time Warner (Chakravorty and Adegoke). Rather than accept a lowball offer, MGM’s creditors voted for bankruptcy reorganization, which allowed them to retain ownership of the studio (Spector). MGM’s precipitous loss in value was tied to its chief asset: its 4,100-title film library, which includes all post1986 MGM films as well as the films of United Artists and Orion Pictures, among other studios. MGM’s value as a producer and distributor was negligible; its only theatrical release in 2010 was the modestly budgeted comedy Hot Tub Time Machine. In contrast, its library held such lucrative properties as the James Bond franchise, itself worth as much as $1 billion, and the distribution rights to J. R. R. Tolkien’s The Hobbit (Schuker and Spector). However, by 2010 the value of the MGM library had depreciated due in large part to an industry-wide decline in home video revenue—a 14 percent drop since 2004 (White).1 At the time of the sale to the Sony consortium, MGM was earning over $500 million annually from its library; by 2009 this had plummeted to $228 million (Spector and Schuker, “MGM Drama”). Revenue from the sale of MGM DVDs dropped from $140 million in 2007 to only $30 million in 2010 (Epstein, “MGM Follies”). Sony’s purchase of MGM’s library helped its Blu-ray highdefinition system defeat HD-DVD in a format war, but this was little consolation to the Wall Street investors who had gambled on the durability of the home video The Warner Archive and DVD Collecting in the New

The Supply Chain Effects of Bankruptcy

This paper examines how a firm’s financial distress and the legal environment regarding the ease of bankruptcy reorganization can alter product market competition and supplier–buyer relationships. We identify three effects—predation, bail-out, and abetment—that can change firms’ behavior from their actions in the absence of financial distress. The predation effect increases competition before potential bankruptcy as the nondistressed competitor behaves as if it has some first-mover advantage that could benefit a supplier with price control. The bail-out effect reflects the supplier’s incentive to grant the distressed firm concessions to preserve competition, improving supply chain efficiency and providing support for the exclusivity rule in Chapter 11 of the United States Bankruptcy Code when the supplier and the distressed firm are financially linked. The abetment effect is that the supplier may deliberately abet the competitor’s predation, leading to increased operational disadvantages for the distressed firm before bankruptcy. Together these effects stress that a firm’s bankruptcy potential can hurt its competitors and benefit its suppliers/customers. They also provide guidelines for firms’ operational decisions in such situations, a rationale for observed firm actions surrounding bankruptcies, and motivation for policies supporting reorganization and relaxing broad enforcement of nondiscriminatory pricing regulations. This paper was accepted by Serguei Netessine, operations management.

Are firms on the right page with Chapter 11? An analysis of firm choices that contribute to post-bankruptcy survival

Historically, corporate bankruptcy reorganization has generated varying results with respect to subsequent firm performance. Some firms reorganize effectively and emerge as more efficient and productive enterprises. However, other inefficient companies strive to survive by utilizing the rehabilitative process of Chapter 11; though liquidation might be a more suitable course of action. This study investigates which characteristics of firm performance and Chapter 11 bankruptcy are linked to successful emergence upon reorganization. We find that the strongest contributor to post-bankruptcy survival is having new management in place. This suggests that Chapter 11 can be utilized as an effective rehabilitative tool in the ‘right hands’.

Value Destruction in the New Era of Chapter 11

Over the past two decades, control over the US bankruptcy reorganization process has shifted from a debtor's pre-bankruptcy managers to holders of secured claims. The result has been increased adherence to absolute priority and a harder landing for the debtor's managers and shareholders. Because managers still make or can influence the decision whether or when to file a bankruptcy petition, we hypothesize that anticipation of bankruptcy under these new conditions will result in a delay in filing, increased leverage, increased secured debt, and a reduction of asset value for firms at the time they file. We present empirical evidence consistent with our hypotheses.

Mexico's Retrogression: Implications of a Bankruptcy Reorganization Gone Wrong

Mexico is retrogressing, becoming an unpredictable and risky jurisdiction for the adjudication of legitimate claims involving domestic and international lenders and investors. This conclusion follows from an analysis of the precedent-setting corporate workout involving a major Mexican multinational (Vitro) now winding its way through the Mexican courts. It raises serious doubts about the capacity of that country’s insolvency regime to deliver an outcome viewed as fair and consistent with prevailing norms and practices in the United States and other reputable jurisdictions. The case may well have a chilling effect on the easy access to foreign financing that Mexican corporations have enjoyed during recent years. The Vitro case has the potential to complicate even U.S.-Mexico diplomatic relations.

Value Destruction in the New Era of Chapter 11

Over the past two decades, control over the US bankruptcy reorganization process has shifted from a debtor's pre-bankruptcy managers to holders of secured claims. The result has been increased adherence to absolute priority and a harder landing for the debtor's managers and shareholders. Because managers still make or can influence the decision whether or when to file a bankruptcy petition, we hypothesize that anticipation of bankruptcy under these new conditions will result in a delay in filing, increased leverage, increased secured debt, and a reduction of asset value for firms at the time they file. We present empirical evidence consistent with our hypotheses.

The Impact of Bankruptcy Reorganization on Operational Competitiveness and Supply Chain Performance

This paper examines how a firm's financial distress and the legal environment regarding the ease of bankruptcy reorganization can alter product market competition and supplier-buyer relationships. We identify three effects, predation, bail-out, and abetment, that can change firms' behavior from their actions in the absence of financial distress. The predation effect increases competition before potential bankruptcy as the non-distressed competitor behaves as if it has some first-mover advantage, which could benefit a supplier with price control. The bailout effect reflects the supplier's incentive to grant the distressed firm concessions to preserve competition, improving supply chain efficiency and providing support for the exclusivity rule in Chapter 11 of the United States Bankruptcy Code when the supplier and the distressed firm are financially linked. The abetment effect is that the supplier may deliberately abet the competitor's predation, leading to increased operational disadvantages for the distressed firm before bankruptcy. Together these effects stress that a firm's bankruptcy potential can hurt its competitors and benefit its suppliers/customers. They also provide guidelines for firms' operational decisions in such situations, a rationale for observed firm actions surrounding bankruptcies, and motivation for policies supporting reorganization and relaxing broad enforcement of non-discriminatory pricing regulations.

The Warner Archive and DVD Collecting in the New Home Video Market

The Warner Archive and DVD Collecting in the New Home Video Market Bradley Schauer (bio) In November 2010 Metro-Goldwyn-Mayer, once known as the “Tiffany of Studios,” filed for Chapter 11 bankruptcy protection after failing to find a buyer willing to assume its nearly four-billion-dollar debt (Spector). While an investment consortium led by Sony Corporation had purchased the studio for $4.9 billion in 2004, six years later the highest bid received for MGM was $1.5 billion from Time Warner (Chakravorty and Adegoke). Rather than accept a lowball offer, MGM’s creditors voted for bankruptcy reorganization, which allowed them to retain ownership of the studio (Spector). MGM’s precipitous loss in value was tied to its chief asset: its 4,100-title film library, which includes all post-1986 MGM films as well as the films of United Artists and Orion Pictures, among other studios. MGM’s value as a producer and distributor was negligible; its only theatrical release in 2010 was the modestly budgeted comedy Hot Tub Time Machine. In contrast, its library held such lucrative properties as the James Bond franchise, itself worth as much as $1 billion, and the distribution rights to J. R. R. Tolkien’s The Hobbit (Schuker and Spector). However, by 2010 the value of the MGM library had depreciated due in large part to an industry-wide decline in home video revenue—a 14 percent drop since 2004 (White).1 At the time of the sale to the Sony consortium, MGM was earning over $500 million annually from its library; by 2009 this had plummeted to $228 million (Spector and Schuker, “MGM Drama”). Revenue from the sale of MGM DVDs dropped from $140 million in 2007 to only $30 million in 2010 (Epstein, “MGM Follies”). Sony’s purchase of MGM’s library helped its Blu-ray high-definition system defeat HD-DVD in a format war, but this was little consolation to the Wall Street investors who had gambled on the durability of the home video market and lost approximately a billion dollars in the deal (Epstein, “The MGM Follies”). The fate of MGM vividly illustrates the threat posed to the major studios by the current decline in home video revenue as consumers begin to abandon the purchase of physical discs in favor of a less expensive rental model. One of the most prominent strategies through which studios have attempted to retain the value of their libraries is through the online sale of “manufacture-on-demand” (MOD) discs of catalog titles. This distribution method, characterized by relatively low production costs and relatively high retail prices, allows studios to expedite the release of their large libraries onto DVD and to maximize the revenue generated from their less popular library product. MOD therefore represents a last-ditch effort for studios to monetize the more obscure corners of their libraries via a sell-through, physical distribution model before the predicted supplanting of that model by digital streaming, rental-based services. The MOD system is presently the primary method of retail for older (pre-1990) films that have not seen a previous home video release; at the time of writing, there are well over a thousand discs available for purchase online. Focusing on the Warner Archive, the first and largest of the studio MOD programs, this article offers a detailed look into the economics of MOD, a topic previously unexplored in academic media industry studies. After first establishing the industrial context for the rise of MOD programs, namely, the decline in the traditional DVD market since 2007, I position MOD as a key example of “Long Tail” retailing, in which a wide variety of commodities with narrow appeal are cheaply marketed and sold to niche audiences via the Internet. Yet while MOD exploits some of the efficiencies of digital convergence, it also retains the inefficiencies of physical distribution and compares unfavorably to conventional DVDs in terms of [End Page 35] consumer value. Based on the reduction of production costs and the elimination of inventory costs, the economic principles of MOD programs lead them to ignore many of the characteristics of the traditional DVD sell-through model that proved so lucrative for studios from...

Game-Theoretic Bankruptcy Valuation

AbstractThe rules of bankruptcy reorganization in the United States permit a debtor to retain a secured claim’s collateral in exchange for judicially approved compensation even over the objection of the secured creditor. An alternative would grant a secured creditor the right to recover its collateral unless satisfied with the compensation, a right often implicit in modern bankruptcy practice despite the formal rules. Either debtor or secured creditor domination of the bankruptcy process may yield inefficient continuation decisions, violations of absolute priority, and high transactions cost. As a remedy to these pitfalls, a mechanism that would mediate between debtor and creditor control and could harness the parties’ information about collateral value is proposed here: junior interests would, on behalf of the debtor, propose a reorganization plan that could include a take-it-or-leave-it offer for collateral with assured liquidation of the collateral being the consequence if the secured creditor rejected...

The Causal Effect of Bankruptcy Law on the Cost of Finance

We exploit the staggered nature of the Italian bankruptcy law reform of 2005-2006 to disentangle the distinct causal impact of both reorganization and liquidation procedures in bankruptcy on firms' cost of loan financing. Using a unique loan-level dataset covering the universe of firm funding contracts we present two major findings: first, that the introduction of a reorganization procedure increased the interest rates on loan financing; second, that the reform that accelerated the liquidation procedure not only decreased firms' cost of finance but also relaxed credit constraints.