Resolution Of Financial Distress Research Articles

Shareholder-Creditor Conflict and the Resolution of Financial Distress

Abstract Constructing a comprehensive data set of financially distressed firms that restructured their debts from 2000–2014, we find that firms with financial institutions’ loan-equity simultaneous holdings are more likely to restructure out of court than to file for bankruptcy. The effect is stronger when loans are oversecured and when the expected bankruptcy costs are larger. We use mergers of financial institutions and instrumental variable estimations to address potential endogeneity concerns. Firms with simultaneous holdings experience higher stock returns. The evidence suggests that mitigating shareholder-creditor conflict results in cost-effective resolutions of financial distress. (JEL G20, G30, G33)

Does the Board of Directors Influence the Likelihood and Resolution of Financial Distress

Does the Board of Directors Influence the Likelihood and Resolution of Financial Distress

Does the board of directors influence the likelihood and resolution of financial distress

Does the board of directors influence the likelihood and resolution of financial distress

Intercreditor Agreement and Contractual Restructuring of LBOs

Abstract 547Leveraged buyout (LBO) transactions are corporate acquisitions financed with multiple layers of debt and equity and form a large subset of the leveraged finance markets. In European LBOs various creditor-categories, the priorities, control and restructuring options are invariably controlled by intercreditor agreements. They set out a basis for a privatised insolvency procedure. Such privatised procedures are often considered both theoretically and practically impossible because of the risk of strategic creditor actions, the incomplete contracting problem, the incentive effects of agency costs and the difficulties of creditor coordination. This article sets out empirical findings how English law governed intercreditor agreements deal with strategic creditor actions and difficulties in creditor coordination, while creating a structured bargaining space for resolution of financial distress. The empirical analysis consists of content analysis of market ICAs and interviews. I argue that contractual solutions for dealing with financial distress in corporate finance are both theoretically and practically possible. ICAs deal with the most important strategic creditor actions and enable effective restructuring to take place contractually. Also, they can operate between sophisticated multi-round players and without necessarily resorting to the statutory procedures.548

Secured and unsecured debt in creditor-friendly bankruptcy

This article develops a continuous-time asset pricing model for valuing corporate securities in the presence of both secured and unsecured debt. We consider a framework where creditors dominate the negotiation process. This is consistent with the increasing influence of creditors in bankruptcy. We show that the unsecured creditors are incentivized to liquidate the firm prematurely relative to the first-best threshold. However, if the firm’s liquidation value is very low, it should complement its secured debt with unsecured debt as a form of insurance to avoid early liquidations. Our results have important implications for the debt structure and the resolution of financial distress of modern firms with substantial intangible assets.

Political connections, informational asymmetry, and the efficient resolution of financial distress

We show that securities issued by a distressed firm, often through exchange offers, provide the most efficient resolution of financial restructuring. Information asymmetry between the firm-bank coalition and small bondholders gives rise to other forms of distress resolution such as refinancing, public workout, and the inefficiency of liquidation. We find that political lobbying by the firm-bank adds to these inefficiencies and inhibits the development of a private market for distressed securities. Cross-country evidence is consistent with this and indicates that improved creditor rights, and the depth of information available to creditors reduce the likelihood of inefficient distress resolution.

Stiffing the creditor: Asset verifiability and bankruptcy

Evidence suggests that asset pledgeability, debt complexity, and control rights of dispersed debt influence financial distress resolution. We model how courts’ imperfect verifiability of assets and valuable control of misaligned creditors shape firms’ debt structure and create coordination problems that determine distress outcomes and financing. A key result is that an increase in verifiability allows financially constrained firms to fund projects by pledging more assets to misaligned creditors, making contract renegotiation in distress times more difficult and increasing the probability of bankruptcy. Since equity receives less in the event of distress, constrained firms choose riskier projects with higher returns. Consistent with our model, bankruptcy filings increase after the U.S. Supreme Court decision imposing a “market test” to assess the value of stockholders’ interest in debtor proposals. The effect is stronger for firms with low asset verifiability. These firms also experienced an increase in recovery rates, debt capacity, and risk-taking. Our findings suggest that reforms improving the verifiability of assets substantially impact credit access. However, our results also point out that improving asset verifiability may be insufficient for constrained firms with aligned creditors. Therefore, complementary reforms that facilitate firms’ access to creditors from different market segments may be necessary.

The Role of Institutional Investors in Financial Distress Resolution

The Role of Institutional Investors in Financial Distress Resolution

Private Equity and the Resolution of Financial Distress

Abstract We examine the role private equity (PE) sponsors play in the resolution of financial distress of portfolio companies. PE-backed firms have higher leverage and default at higher rates than other companies borrowing in leveraged loan markets. But, PE-backed firms restructure more quickly, avoid bankruptcy court more often, and liquidate less often compared to other highly leveraged firms experiencing financial distress. PE owners are also more likely to retain control post-restructuring, often by infusing capital as firms approach distress. While default frequencies are higher among PE-backed firms, PE investors appear to manage financial distress at lower cost compared to other owners. (JEL G23, G32, G33)

Capital Adequacy Regulation and Financial Distress Resolution in the Nigerian Banking Industry: An ARDL Approach

This paper investigates the impact of capital adequacy regulation on financial distress resolution in the Nigerian banking industry within the ARDL framework using aggregate time series data. Financial distress resolution is measured by ratio of distressed banks, while capital adequacy regulation is measured by credit to risk weighted assets ratio, capital to total assets ratio and assets to capital ratio. The sample comprises annual time series data covering the period from 1986 to 2018, while the data are obtained from three reliable sources: namely, Central Bank of Nigeria (CBN) statistical bulletin, Nigeria Deposit Insurance Corporation (NDIC) quarterly and Nigeria Stock Exchange (NSE) fact sheet. The plausible ARDL specification is determined using the Schwarz information criterion, which selects a model with two lagged values of ratio of distressed banks as additional explanatory variables. We find that financial distress resolution exhibits persistence behavior and depends on its two lagged values, but with a positive and sizable net own effect. However, the relationship between financial distressed resolution and capital adequacy regulation measures has no lagged effect. Also, both the individual and joint impacts of the three capital adequacy regulation ratios are not statistically significant. Based on these findings, we conclude that capital adequacy regulation is not an important determinant of financial distress resolution in Nigeria, and that the regime of risk-based capital regulation may produce further moral hazards behavior in the Nigerian banking sector.

Liquidity Management, Basel Capital Adequacy and Financial Distress Resolution in the Nigerian Banking Industry

The purpose of this study is to analyze the effect of liquidity management and BASEL capital adequacy on financial distress resolution in Nigeria. The study adopts a unidirectional causal research design within the single-equation dynamic autoregressive distributive lag (ARDL) framework. The empirical analysis is based on annual time series data covering the period from 1986 to 2018 obtained from different Central Bank of Nigeria (CBN) statistical bulletin and Nigeria Deposit Insurance Corporation (NDIC) quarterly as well as the factsheet of the Nigerian Stock Exchange (NSE). The stationarity test results indicate that the study variables are integrated at different levels, with most of them being I(1) series. The ARDL results show that micro-prudential liquidity management has no significant effect on ratio of distressed banks, while the effect of macro-prudential liquidity management on ratio of distressed banks is significant. The results also show that capital adequacy regulation has no significant effect on both ratio of distressed banks and governance/compliance breaches of distressed banks, while it has a significant effect on business risks exposure of the distressed banks and asset quality of distressed banks. Further, monetary policy measures have no significant effect on the level of distress in the Nigerian banking industry. Based on these findings, we conclude that in Nigeria, prudential measures aimed at achieving macro-level financial sector stability have significant policy implications for financial distress resolution. Also, while traditional monetary policy measures are not effective tools for achieving financial sector stability, the effect of capital adequacy regulation on financial distress resolution depends on how the former is measured. The main contribution of this study is the use of Newey-West robust framework, which consistently estimated the effect of liquidity management and BASEL capital adequacy on financial distress resolution even when both heteroskedasticity and autocorrelation are present in the data.

The impact of tunnelling on financial distress and resolution: Evidence from listed firms in China

AbstractWe examine the impact of tunnelling on financial distress in Chinese stock markets, where the agency problem is common due to the weak legal system protecting minority shareholders' interests. Investigating the widespread financial distress among listed firms during the time period 1999–2015, we find that tunnelling is a determinant of financial distress–tunnelling not only leading to financial distress but also prohibiting distress recovery. Regulatory improvements aiming to reduce tunnelling behaviour contribute to the resolution of financial distress, but there is still room to improve. Our results show that state ownership has limited influence on firm operation before financial distress but tends to benefit recovery from periods of distress, which depicts the market economy mechanism in China. Our findings are robust to the potential endogeneity issue and various measures of financial distress.

Corporate Financial Distress and Reorganization: A Survey of Theoretical and Empirical Contributions

Purpose – This paper presents both a theoretical and empirical review of the bankruptcy and reorganization literature. We point out the main articles developed in the field and present a group of studies carried out after the approval of the new bankruptcy law in Brazil. Design/methodology/approach – This paper provides a survey of the literature on bankruptcy and corporate reorganization. We investigate classic and recent papers in the field and present the results of some Brazilian studies that consider the announcement of the Brazilian bankruptcy law in 2005. Findings – We show that information asymmetry, coordination problems, and heterogeneity between creditors are pivotal to the resolution of financial distress. Moreover, the choice of restructuring is made according to the least-cost alternative. We discuss the practical implications of the literature by analyzing three cases of reorganization in Brazil and reveal that the complexity of each case can drive the decision to approve or reject the reorganization plan. Originality/value – We investigate the evolution of the bankruptcy and reorganization literature and provide a survey that explores both the international and Brazilian literature.

When the going gets tough: Private equity firms’ role as agents and the resolution of financial distress in buyouts

ABSTRACT Previous research has focused on a private equity (PE) firm’s role as principal in its relationship with an investee, but few studies have looked into their role as agents for their investors. We examine how a PE firm’s relationship as agent for limited partners (LPs) and banks influences its incentives to resolve financial distress in the investee. We examine the effect of PE fundraising reputation, PE fundraising activity, and PE bank affiliation on the likelihood of a financially distressed buyout ending in bankruptcy. We build a unique data set of 338 distressed buyouts in the United Kingdom to test our hypotheses.

Use of formal insolvency procedure and judicial efficiency in Spain

In the framework of law and finance literature, this study focuses on analysing the impact of judicial efficiency in firms’ decision on the use of court proceedings in the resolution of financial distress. The question as to whether the use of formal bankruptcy procedures can be related to efficiency in the implementation of legislation by the courts has been posed. The scarce empirical evidence has focused on the analysis of the impact of judicial efficiency at the international level, which implies assumption that the degree of efficiency is similar within each country. However, studies from Brazil and Spain have revealed the existence of differences among districts within the same country and its impact on different economic and financial aspects. Consequently, the work focuses on a single country allowing to isolate the effect of the content of the legislation from the efficiency of the application of these legal rules by the courts. The sample consists of 4160 unlisted firms in Spain experiencing financial difficulties, among which are companies that have and have not opted to use the formal bankruptcy proceedings. The results indicate that firms located in Spain’s autonomous communities that exhibit a higher efficiency of their judicial systems are more likely to use court proceedings to resolve financial distress.

Strategic Default, Investment and the Resolution of Financial Distress

In recent years the U.S. experienced an increase in the share of default events that are resolved out-of-court, as well as a reduction in bankruptcy-related costs. This trend raises the question as to what drives the frequency with which defaults turn into bankruptcies. We propose a theory based on three pillars: first, bankruptcy is costlier than out-of-court restructuring; second, creditors cannot commit to take defaulting borrowers to court; third, firms have private information about the value of their assets, outside investors only learn them only upon bankruptcy. Creditor’s bargaining power upon default decreases with bankruptcy costs and it increases with the frequency of strategic default – that is, default by firms which could have honored their obligations. When bankruptcy costs decrease, creditors obtain higher recovery rates out-of-court and therefore firms have lower incentives to default strategically. As a result, bankruptcy can occur less frequently.

Renegotiation Frictions and Financial Distress Resolution: Evidence from CDS Spreads*

We study how renegotiation frictions impact distressed debt resolution and ex-ante financial contracting. We do so by exploiting an event that exogenously reduced the costs that syndicated lenders incur when renegotiating debt out of court, without affecting in-court restructuring costs (IRS Regulation TD9599). CDS contracts insure creditors against in-court bankruptcy losses and CDS spreads reflect the shadow price of bankruptcy risk. Using a triple-differences approach, we show that CDS spreads fell by record figures on the event’s announcement, with declines concentrated among distressed firms that relied most on syndicated loans. Distressed firms’ loan renegotiation rates more than doubled, as banks agreed to extend loan maturities in exchange for higher interest payments. Those firms’ access to new syndicated loans increased while associated interest markups declined.

Simultaneous Debt-Equity Holdings and The Resolution of Financial Distress

Constructing a comprehensive data set of financially distressed firms that restructured their debts from 2000-2014, we find that firms with financial institutions’ debt-equity simultaneous holdings are more likely to restructure out of court than to file for bankruptcy. The effect is stronger when loans are over-secured and when the expected bankruptcy costs are larger. We use mergers of financial institutions and instrumental variable estimations to establish causality. Firms with simultaneous holdings experience higher stock returns and are not more likely to reenter into financial distress. The evidence suggests that the mitigation of shareholder-creditor conflicts results in cost-effective resolutions of financial distress.

Resolution of financial distress under agency frictions

Abstract We introduce, in a dynamic-contracting framework with moral hazard, the possibility of recapitalization as an alternative to liquidation when a firm is distressed. This is achieved by considering a risk-averse agent and by allowing (but not requiring) the latter to inject additional capital into the firm when necessary. We show that firm recapitalization may arise in an optimal, long-term contract. As a consequence, we find that there are two mechanisms at a firm’s disposal so as to deal with financial difficulties: one corresponds to a recapitalization process, the other to a liquidation one. The choice of mechanism is based on a cost-benefit analysis.

A Survey of Corporate Bankruptcy Reforms: Lessons to Be Learnt for Worldwide Good Practices

Recent years have witnessed a phenomenal upsurge in the number of corporate bankruptcies. The vulnerabilities which were lying dormant within contemporary bankruptcy regimes suddenly became apparent, causing concerns within the international corporate community. Consequently, researchers, practitioners and policy makers from all over the world got actively engaged in emphasizing the importance of efficient bankruptcy reforms for promoting rescue culture. The primary objective of an insolvency framework should be to provide quick, transparent and cost effective solutions for the resolution of financial distress and promotion of a synergetic environment conducive for the proliferation of healthy debt repayment practices, increased trust factors between creditors and debtors and a better survival rate for viable businesses. In this paper we present a qualitative review of various insolvency reforms introduced in nearly 189 economies over a decade (2005 to 2015), for the efficient resolution of financial distress. For data collection purpose, we use World Bank Database from Doing Business Reports (2005-2015). We provide latest data on the recovery rates, costs, time for resolution based on recent statistics (until June 2015). Finally, we present a list of most popular reforms in bankruptcy and also when possible the effect of their application. This is one of the comprehensive surveys on worldwide corporate bankruptcy reforms. *