Distressed Firms Research Articles

Trade Receivables Policy of Distressed Firms and its Effect on the Costs of Financial Distress

This paper studies the trade receivables policy of distressed firms as the trade off between the firm's willingness to gain sales and the firm's need for cash. We find that firms increase trade receivables when they have profitability problems prior entering financial distress, but reduce trade receivables when they have cash flow problems in financial distress. We also find that a firm that significantly cuts its trade receivables when in financial distress will have an additional 7% drop in sales and stock returns over the previously documented 24% average drop for a firm in financial distress. Moreover, the performance decline of a firm in financial distress is significantly higher if the firm cuts trade receivables than if it does not.

You Can Innovate In Hard Times

OVERVIEW:Achieving sustained organizational innovation has proved an almost insurmountable challenge for most firms, and is even more challenging in difficult economic times. Most firms are unprepared for hard times, and typically respond with draconian measures such as budget cuts and layoffs, short-term, finite actions that lead eventually to diminished returns. A review of the literature reveals little advice beyond exhorting firms to develop an enduring innovation culture a priori, before times get difficult. Once beyond finite actions, however, firms have an opportunity to examine other, more systemic and tactical practices for pursuing growth opportunities under austere financial conditions. These can address both the specific causes of the firm's economic distress, and achieve longer-term innovation that will help rebuild the firm and to some degree inoculate it against future turbulence.

Conflicts of Interest in Japanese Insolvencies: The Problem of Bank Rescues

Economists and legal scholars routinely posit an implicit contract between Japanese firms and their principal lender (called their bank). Under this arrangement, the bank implicitly agrees to rescue the firm (through financial and managerial help) when times turn bad. Out of court, it rescues the firm from insolvency. Not only does it save the investments specific to the troubled firm, it lowers the use of costly bankruptcy proceedings and cuts the costs of those bankruptcy procedures it does occasionally invoke. Given the creditor-shareholder conflicts of interest that arise as firms approach insolvency, such arrangements would seem unstable. Yet according to a long sociological tradition, conflicts of interest are inherently less problematic in Japan than in the West. According to the emerging economic and legal tradition, Japanese economic actors do face those conflicts, but keep them in check through reputational concerns, close-knit ties, and government supervision. Using two datasets of troubled firms from the 1970s and 1980s, we ask whether Japanese main banks in fact rescue distressed borrowers. We find no evidence that they do: large Japanese firms fail; when large firms approach insolvency main banks do not increase the share of the firm's debt they bear; stronger ties between distressed firms and their main bank do not facilitate loans; and troubled firms do not try to preserve their main bank relationship. Instead, the claim that Japanese banks implicitly agree to rescue firms is sheer myth. Conflicts of interest do indeed matter in Japan - and they matter enough to prevent precisely the incentive-incompatible rescue deals that scholars in the field so routinely posit.

Artificial neural networks in reorganization outcome and investment of distressed firms: The Taiwanese case

Using a sample of 59 Taiwanese firms in distress, we investigate investor gains or losses around the filing date and the confirmation date of the reorganization plan and propose ex ante trading strategies that can generate potentially substantial returns from these stocks. We further experiment with a novel approach to sensitivity analysis of neural network inputs for refining and rating the most important input variables and then construct artificial neural network (ANN) models to classify and predict the post-reorganization filing resolutions in a three- (Model 1) and two-group (Models 2 and 3) resolution setting. We are unaware of any other paper that has used artificial intelligence techniques in analyzing post-bankruptcy resolutions. The results show that our five-variable models produce a consistent estimate between the training and testing sets; that is, both three- and two-group models are of a high degree of accuracy and stability, demonstrating the robustness of the ANN models.

Insolvency Problems in the European Union: Bankruptcy Law Orientation and Market Valuation

The reaction of stock prices to bankruptcy filing announcements has been very frequently analysed in the financial literature. In the current work we adopt a different approach to that of the traditional event study, trying to determine if the reaction of the markets is conditioned by the orientation of the bankruptcy legislation that regulates cases of corporate insolvency. With this aim in mind, we undertake an analysis on a sample of firms in financial distress in France, Germany, Spain and the UK between 1990 and 2002. Our results lead us to conclude that the valuation of the firms' securities is indeed conditioned by the type of bankruptcy law. In addition, we find that firms under creditor-oriented systems (Germany before the 1994 reform and the UK) present more negative returns due to the transference of wealth from the shareholders to the bondholders of the firms.

The Characteristics of Corporate Distress in an Emerging Market: The Case of China

This paper is one of the first studies to empirically examine the nature and cause of financial distress in an emerging market context. This is important given the impact of the recent global privatization phenomenon. These privatized firms have since been subject to a new competitive environment, redefined objectives and management incentives. In this context, we investigate the characteristics of a sample of 100 distressed firms in China between 1999 and 2003. Existing bankruptcy and distress literature cites two main causes of financial distress: debt overhang and economic distress. By comparing the distressed firms' financial and operating performance with that of their respective industries, we conclude that corporate distress in China is caused predominantly by firm level poor operating performance, not by leverage. Our evidence indirectly speaks to the debate that financial renegotiations between distressed firms and their creditors are inefficient. In addition, our sample provides a unique opportunity to study how (partial) government ownership affects firm performance and efficiency in the context of financial distress and soft budget constraints.

Reputation and Spillovers: Evidence from Indian Business Groups

We investigate the importance of reputation-based implicit contracts in firm financing in the context of Indian Business Groups. The group structure enables us to cleanly analyze the negative spillovers on other firms, triggered by a member firm defaulting on its debt obligations. We hypothesize that business group insiders will support financially distressed member firms in order to maintain the group's reputation. The default by a group firm will damage a group's reputation - making it more difficult for the remaining firms to raise capital, thereby affecting their performance and survival. We show this to be the case for our sample: Groups use intra-group loans to support member firms in financial distress and, as a result, firms belonging to groups with unimpaired reputation are less likely to become bankrupt, relative to stand alone firms. The first bankruptcy in a group is followed by a significant drop in the amount of external finance raised, a discontinuous drop in investments and profits, and an increase in the bankruptcy probability of other healthy firms in the group. Consistent with loss of reputation being the reason for these spillovers, we find that negative consequences are more severe for firms in the group with closer managerial links to the bankrupt firm and for firms which depend more on external finance.

Client Firms and Bank Mergers: Positive Wealth Effect of Bank Mergers on Distressed Firms

Using the event study method, Karceski et al. (2000) and Shin et al. (2003) determined that investors expected bank mergers to adversely impact some of the borrowing firms. Earlier studies on the effects of banking merger on borrower have not sufficiently considered the relationship between the economic conditions of the borrowers and the wealth effect of the bank mergers. Using the events study method, we investigated whether the news of several bank mergers between Japanese banks affected the market value of financially distressed borrowers. We found that news of bank mergers brought about a positive wealth effect on financially distressed borrowers.

The Effect of Accounting Conservatism on Measures of Distress Risk

This paper investigates how the trend in accounting conservatism effects measures of financial distress. We find that existing accounting-based measures of financial distress become less accurate as accounting conservatism increases across time. We document that (1) higher levels of accounting conservatism increase the likelihood of misclassification of solvent firms (2) adjusting for conservatism increases the number of correctly identified distressed firms by an average of 13% per year (3) adjusted measures of distress eliminate the previously documented anomalously low returns of large high distress risk firms with low book-to-market and (4) adjusted O-score measures provide important information on distress risk for large firms with average book to market classification. Our results suggest that extant literature relying on accounting measures of distress incorrectly predicts or controls for distress risk.

Trade Credit and Monetary Policy in the UK: An Empirical Investigation

The credit channel of monetary transmission suggests that monetary tightening results in a contraction of the supply of credit to firms who borrow via financial intermediaries. However, according to Meltzer (1960), the existence of an inter-firm credit flow appears to favour those firms most affected by credit rationing. This study re-analyzes Meltzer's hypothesis using UK data. The results of the analysis shows that indeed there is an increase in trade credit flows in period of rising interest rates, but the magnitude is not very significant overall. Firms of different financial status, however, behave differently. The novel finding is that small firms extend trade credit more aggressively than medium and large firms. This behaviour occurs even in those firms in financial distress. Interestingly, this behaviour may be one of the reasons that cause small firms that cannot receive trade credit from their suppliers in period of monetary contraction, to go bankrupt.

Default risk, systematic risk and Thai firms before, during and after the Asian crisis

This paper applies the Merton [Merton, R., 1974. On the pricing of corporate debt: the risk structure of interest rates. J. Finance 2 (2), 449–470] default probability model to the firms in the SET50 index at the Stock Exchange of Thailand (SET). It also examines the relationship between a firm's default probability and firm-specific characteristics like size and book-to-market ratio, and whether default risk is systematic or not. We believe this to be the first paper dealing with these issues using data from an emerging country. The study also differs from other studies by dealing with how the default risk of firms in different sectors of the economy changes during a severe crisis. Overall, we find a significant increase in market based default probabilities around the crisis and a fairly slow return to pre-crisis levels. The first sector to suffer a deterioration in creditworthiness was the sector of finance and securities firms and the worst effected sector at the peak of the Asian crisis was the building materials sector. There are further some indications of the most distressed firms being on average somewhat smaller than the least distressed, but only during the crisis. We do not find significant evidence of the book-to-market ratio being related to the default risk in this particular market, though. Finally, if default risk is systematic, one would expect that default risk is rewarded by higher returns. However, in this sample the level of default risk of a firm does not seem to be able to explain the firm's subsequent realized returns at different horizons. We therefore reject the hypothesis that default risk is systematic.

Conflicts of Interest in Japanese Insolvencies: The Problem of Bank Rescues

Economists and legal scholars routinely posit an implicit contract between Japanese firms and their principal lender (called their "main bank"). Under this arrangement, the bank implicitly agrees to rescue the firm (through financial and managerial help) when times turn bad. Out of court, it rescues the firm from insolvency. Not only does it save the investments specific to the troubled firm, it lowers the use of costly bankruptcy proceedings and cuts the costs of those bankruptcy procedures firms do occasionally invoke. Given the creditor-shareholder conflicts of interest that arise as firms approach insolvency, such arrangements would seem unstable. Yet according to a long sociological tradition, conflicts of interest matter less in Japan than in the West. According to the emerging economic and legal tradition, Japanese economic actors do face those conflicts, but keep them in check through reputational concerns, close-knit ties, and government supervision. Using two datasets of troubled firms from the 1970s and 1980s, we ask whether Japanese main banks in fact rescue distressed borrowers. We find no evidence that they do: large Japanese firms fail; when large firms approach insolvency, main banks do not increase the share of the firm’s debt they bear; stronger ties between distressed firms and their main bank do not facilitate loans; and troubled firms do not try to preserve their main bank relationship. All told, the claim that Japanese banks ever implicitly agreed to rescue firms is sheer myth. That Japanese banks let troubled firms fail is no recent development; it has been thus for decades. Conflicts of interest do indeed matter in Japan and long have. They matter enough to prevent precisely the incentive-incompatible rescue deals that scholars in the field so routinely posit.

Financial Distress and Reputational Concerns

This article examines the interaction between the restructuring process of a financially distressed firm and the behavior of its manager. We analyze a situation in which a bank decides to offer a renegotiation to a distressed firm, yet the manager is reluctant to implement a restructuring even when this would be efficient. We show that a combination of factors, including the bank's monitoring activity and managers' reputational concerns, can explain the reluctance of managers to accept a renegotiation. We analyze the optimal renegotiation o¤er in such a setting and derive some implications about the design of firms. Our model predictions about managers' behavior under reputational concerns are able to match important stylized empirical facts. In particular, Hotchkiss (1995) documents the failure to get distressed firms to provide disclosure statement and to efficiently restructure. While her explanation relates to the US bankruptcy design that allows management to make inefficient self-serving decisions, ours emphasizes managers' reputational concerns.

Late Payments in Accession Countries: Causes and International Comparison

In developed countries in everyday business, payment delays often present a problem. Payment delays have already been a matter of discussion in Slovenia for several years. Irrespective of some positive movements in the past years, the state of payment discipline in Slovenia is not at a satisfactory level. In this area, Slovenia could be classified among the less successful countries when compared to other countries in Europe. Our paper determines factors behind this fact. The findings are important not only for Slovenia, but also for other EU candidate countries faced with similar problems of transition. The paper has led to the following conclusions. Firstly, the more indebted companies have longer payment delays. Secondly, the longer the contractual payment period, the shorter the payment delay. Longer payment periods are mostly received by larger companies. And thirdly, the longer the payment delays on the side of companies? buyers, the higher the incidence of late payments by the company. We can therefore conclude, based on our research, that payment delays in Slovenia depend mostly on risks involved with doing business with firms in financial distress, in particular with small businesses.

KEY SUCCESS FACTORS IN THE REVITALIZATION OF DISTRESSED FIRMS: A CASE OF THE KOREAN CORPORATE WORKOUTS

Journal of Restructuring FinanceVol. 01, No. 02, pp. 311-338 (2004) ARTICLESNo AccessKEY SUCCESS FACTORS IN THE REVITALIZATION OF DISTRESSED FIRMS: A CASE OF THE KOREAN CORPORATE WORKOUTSDONGSOO KANGDONGSOO KANGKorea Development Institute 207-41, Chongnyangri-Dong, Dongdaemun-Gu, Seoul, South Korea Search for more papers by this author https://doi.org/10.1142/S0219869X04000263Cited by:0 PreviousNext AboutSectionsPDF/EPUB ToolsAdd to favoritesDownload CitationsTrack CitationsRecommend to Library ShareShare onFacebookTwitterLinked InRedditEmail AbstractThis paper explores the empirical performances of the workout companies with special interests in the effectiveness of corporate reorganizing tools on their revitalization. In the empirical analysis it considers the criteria of success or failure in restructuring from both creditors' and debtors' perspectives in a separate manner. The key results are summarized as follows. First, the initial conditions on the debt structure of the workout companies are significantly related to the revitalization from both creditors' and debtors' point of view. Second, the debt restructuring instruments are insignificant in the success of corporate turnarounds, but the debt-to-equity conversion has been a relatively effective tool. Third, the self-restructuring efforts, employment downsizing, and governance reshuffling do not affect the performances significantly.Keywords:Corporate distresscorporate workoutsreorganizationJEL Classification: G34JEL Classification: G38JEL Classification: C35 References C. Adams , R. E. Litan and M. Pomerleano , Managing Financial and Corporate Distress: Lessons from Asia ( Brookings Institution Press , 2000 ) . Google ScholarE. C. Altman, Journal of Finance (1968). Google Scholar J. Bhandari and L. Weiss , Corporate Bankruptcy: Economic and Legal Perspectives ( Cambridge University Press , 1996 ) . Crossref, Google Scholar M. Dado and D. Klingebiel , Decentralized Creditor Led Corporate Restructuring: Cross Country Experiences ( Worldbank , 2000 ) . Google Scholar Financial Supervisory Service (2003). A Five-Year Experience on the Corporate Workouts . Google Scholar P. A. Gaughan , Mergers, Acquisitions and Corporate Restructurings , 2nd edn. ( John Wiley & Sons, Inc. , 1999 ) . Google ScholarJ. Gilson and Lang, Journal of Financial Economics 27(1990), 315 (1990), DOI: 10.1016/0304-405X(90)90059-9. Crossref, Google ScholarJ.-H. Hahm and F. S. Mishkin, The Korean Crisis: Before and After, ed. I. Shin (Korea Development Institute, Seoul, 2000) pp. 55–144. Google ScholarE. S. Hotchkiss, Journal of Finance 50(1995), 3 (1995), DOI: 10.2307/2329237. Crossref, Google Scholar J.-R. Jeong and E.-J. Hong , Distressed Assets Resolution: A New Frontier of Financial Industry ( Samsung Economic Research Institute , 2003 ) . Google ScholarS. W. Joh, The Korean Crisis: Before and After, ed. I. Shin (Korea Development Institute, Seoul, 2000) pp. 185–213. Google ScholarD. Kang and S. Hahn, Journal of Korean Economic Analysis 7, 121 (2001). Google Scholar P. Kent , Corporate Workouts — A UK Perspective ( Bank of England , 1997 ) . Crossref, Google ScholarJ.-K. Kim, Journal of Restructuring Finance 1(2), 289 (2004), DOI: 10.1142/S0219869X04000251. Link, Google Scholar Korea Development Bank (2002). Case Studies on Corporate Restructuring . Google Scholar S.-K. Lee , Explanations on the Corporate Workouts for Restructuring Specialists ( Corporate Restructuring Coordination Committee , 2000 ) . Google Scholar Nam, I. C., J.-K. Kim, Y. Kang, S. W. Joh and J.-I. Kim (1999). Corporate Governance in Asia: A Comparative Perspective. OECD Conference Report . Google ScholarJ. Nam, Journal of Finance Studies 12, (1998). Google Scholar , Symposium on Building Effective Insolvency Systems ( 1999 ) . Google Scholar FiguresReferencesRelatedDetails Recommended Vol. 01, No. 02 Metrics History KeywordsCorporate distresscorporate workoutsreorganizationJEL Classification: G34JEL Classification: G38JEL Classification: C35PDF download

ASSESSMENT OF PROGRESS IN CORPORATE RESTRUCTURING IN KOREA SINCE THE 1997–98 CRISIS

This paper shows, based on firm-level data, that by the time of the 1997–98 crisis, Korea's corporate sector, particularly chaebols, became highly vulnerable to bankruptcy. Evidence is presented showing that between the late 1980s and 1997 the debt servicing capacity of Korea's corporate sector was on a decreasing trend due to both deteriorating profit performance and a rising debt leverage. What accounted for the declining profitability in Korea's entire corporate sector? It is argued that the declining profitability was due to rising labor costs in Korea and increasing competition from abundant, developing countries such as China. We also provide evidences that the chaebols with ownership of non-bank financial institutions (NBFIs) had systemically higher debt leverage than the firms without any ownership in NBFIs. This paper moves to assess the interim progress of corporate restructuring since the onset of the crisis. First, the financial vulnerabilities of chaebols have improved significantly during the post-crisis period. Indeed, all indicators show that chaebols consistently out-performed non-chaebol companies following the crisis. In particular, chaebols were able to rapidly reduce their debts. Furthermore, although non-chaebols reduced their debt but at a lower extent, there were no signs of improvement in profitability. Second, the transition matrix based on interest payment coverage ratios shows that a high proportion of firms in the bottom quintile moved up to the upper quintiles, implying that the financially vulnerable firms are able to move up rather than being stuck with poor performance. Third, despite the considerable progress made in corporate restructuring, there remained quite a small number of impaired firms as of 2002; in that year, 25.2 percent of the sample firms are not able to even cover interest payments, let alone the principle, with earnings. Also, in the 2000–2002 period, there were 550 firms suffering similar conditions for three consecutive years. The number of financially weak firms clearly indicates that there still remains the need for further corporate restructuring. Finally, from our study it is reasonable to suggest that rehabilitation proceedings in Korea have made considerable improvements as a result of reform measures implemented following the crisis. The following reforms have worked to enhance rehabilitation procedures, including the introduction of an economic efficiency criterion for the selection of firms for corporate organization, shortened periods for proceedings, the improvement in the due diligence process, and preventing large firms with complex capital structures in entering composition. With all of these measures in place following the crisis, our study shows that the firms in the 1998 cohorts that entered both corporate reorganization and composition out-performed those in the respective cohort in 1997. Though it may be premature to make a definitive assessment, empirical tests suggest that the relatively poor performance of the firms in the workout may be attributed to a slower rate of debt reduction. This may be as a result of the slow progress in devising restructuring plans in the absence of a legal enforceability in workout programs.

Accounting Numbers and Information Asymmetry: Evidence from Loss Firms

This paper studies whether firms reporting losses subsequently experience higher levels of information asymmetry among investors relative to firms reporting profits. Using bid-ask spreads as a measure of information asymmetry, I test whether loss firms have higher bid-ask spreads than profit firms after controlling for determinants of bid-ask spreads as identified by previous literature. I also differentiate between loss firms based on the history of losses and test whether multiple loss firms experience higher bid-ask spreads than single loss firms. The results show that, on average, loss firms have higher bid-ask spreads than profit firms and multiple loss firms have higher bid-ask spreads than single loss firms. Furthermore, the documented positive association between losses and bid-ask spreads is not driven by firms in financial distress. These results suggest that losses may affect the efficient functioning of capital markets through higher levels of information asymmetry.

An Explanation for Bankruptcy's Risk-Return Paradox

The admission of bankruptcy risk into a single-period CAPM economy leads to two surprising results. First, OLS beta is a biased measure of systematic risk. Second, the expected return conditional on the market is no longer a linear function of beta alone. Instead, it is a linear function of the ratio of conditional to unconditional expected dividends and of that ratio times beta. In this economy very distressed firms should underperform the market because of their high option values and strong contributions to portfolio diversification. This is confirmed by empirical tests that replicate Dichev's paradox.

Coordination Failure, Herding and the Signalling Role of Banks in Debt-exchange Offers

This article discusses the out-of-court debt restructuring of firms in financial distress, under conditions of asymmetric information among their creditors and in situations where a creditor bank makes concessions conditional on other creditors' actions. In line with empirical evidence, it is shown that a bank's involvement in the restructuring catalyses success of a debt-exchange offer to other creditors, leading to resolution of financial distress at lower levels of firm fundamentals compared to the situation with no bank in the game. The analysis also derives predictions about the impact of minimum tendering rates on creditors' incentives to restructure and the outcome of debt-exchange offers.

Reputation and the Market for Distressed Firm Debt

Our analysis explains how vulture investors (vultures) can maintain and exploit their rep- utations for toughness. Vultures leverage their reputations to extract concessions from stockholders in debt restructurings. To profit from these concessions, vultures must first acquire debt from incumbent bondholders. Buying only the tranches most likely to render them marginal creditors maximizes vulture leverage in debt-purchase negotiations. Vulture profits are proportional to the degree of uncertainty regarding the identity of the marginal debt class