Corporate Bankruptcy and Bank Competition · Motivation Background Data Regression results...

Motivation Background Data Regression results Identi�cation Conclusion

Corporate Bankruptcy and BankCompetition

Todd Gormley, Nandini Gupta, and Anand Jha

February 21, 2014


Motivation

Bankruptcy procedures can be highly ine¢ cient - increasing cost ofborrowing and decreasing e¢ ciency of resource allocation.

In emerging markets, average duration in bankruptcy >4 years(World Bank, 2012); 50% of �rm value is lost on average(Djankov, et al., 2008).In India - 6.5-7 years for bankruptcy court to render a decisionon restructuring or liquidation. Liquidations take another10-25 years (Panagariya, 2008).


Why are some bankruptcy systems so ine¢ cient?

Literature focuses on di¤erences in bankruptcy law and itsenforcement

Use of bankruptcy related to creditor rights and judiciale¢ ciency (Claessens and Klapper, 2005); recovery ratesdepend on legal system (Davydenko and Franks, 2008); legalorigin important determinant of delays (Djankov et al., 2008).See survey by Hotchkiss, John, Mooradian, and Thornburn,2008.

We focus on creditors�incentives to monitor borrowers andrecover assets.

Pursuing delinquent �rms and recovering assets when creditorrights are weak requires costly e¤ort by creditors. eg. A majorreason for bankruptcy delays in India is a lack of response fromcreditors asked to make concessions in debt restructuring.In uncompetitive banking sector, creditors may prefer to leadthe �quiet life�.


Does banking sector competition a¤ect corporatebankruptcy outcomes?

�The best of all monopoly pro�ts is the quiet life�- SirJohn Hicks (1935)

In absence of competition, bank managers lack the incentiveto undertake the costly e¤ort required to pursue defaultingborrowers when creditor rights are weak.

Managers �prefer to avoid di¢ cult decisions and costly e¤orts�in absence of competition (Bertrand and Mullainathan, 2003;Giroud and Mueller, 2009).

Competition in the banking sector may improve creditors�incentives to more aggressively monitor delinquent borrowersand recover assets more quickly.

Banking sector competition associated with increasede¢ ciency and lower NPLs (Berger and Hannan, 1998;Jayaratne and Strahan, 1996, 1998).


Alternative channels by which banking sector competitionmay a¤ect bankruptcy

Change in supply of credit

Bank entry may increase overall supply of credit, reducing�nancial constraints for �rms.

Shift in allocation of credit

Bank entry may shift lending to better �rms, with easier toresolve bankruptcies.

Bank entry may reduce �nancial access for opaque, riskier, orless pro�table �rms.

We will examine these.


Research design

Examine how a shift in the competitive structure of banks in aregion a¤ects the incidence, outcomes, and duration of corporatebankruptcies in that region.

Exploit bank deregulation in India that led to the entry ofprivately-owned domestic and foreign banks in sectordominated by government banks.

Also examine e¤ect of a change in creditor rights*.


India provides several advantages

Bank deregulation provides sharp break in banking sectorcompetition.

Signi�cant variation in private domestic and foreign bank entryacross regions and years.

Financial markets & bankruptcy process representative ofother emerging markets.

Bankruptcy law does not vary across regions and time, butbanking sector characteristics do.


Preview of �ndings

Increase in banking sector competition in a district isassociated with

Increase in bankruptcy �lings in that district.Decrease in the average duration of bankruptcy.More reorganizations and fewer liquidations.

Results driven by the entry of domestic private banks.

When creditor rights are strengthened...

Above associations are ampli�ed.Foreign banks now matter.

Results most consistent with change in creditor incentives topursue defaulting borrowers and reduce delays in bankruptcyfollowing an increase in competition.


Bankruptcy process in India

All industrial companies �le under Sick Industrial CompanyAct (SICA) of 1985.

File with the federal bankruptcy court based in New Delhi (theBIFR).All �rms with > 50 workers & > 5 years of operations withlosses > net worth have to �le.

Automatic stay on creditor claims once a �rm �les.BIFR takes >1 year on average to determine if �rm is �sick�(truly unable to pay debts).1/3 of cases are dismissed by the BIFR because of evidence of�nancial manipulation/fraud by managers (Govt. of India,2000).

�The best way for Indian companies to avoid repaymentof loans to �nancial institutions seems to be the BIFRroute,� (�Cos take BIFR cover to avoid loan repayment,�The Indian Express, June 27, 1999).

If court �nds �rm to be sick then process continues. . .


Restructuring versus liquidation

By default, sick �rms enter into negotiations with lendersabout reorganizing �rm & its debts.

Board of directors retains control during this process.No provisions to divide creditors into classes or to force them toaccept a plan, which is a contributing factor in the long delays.

If no restructuring agreement reached BIFR may orderliquidation.

Long delays before BIFR renders decision.

Liquidations subsequently take much longer to resolve thanreorganizations (10-20 years in civil courts, Panagariya, 2008).


Bank deregulation led to signi�cant private bank entry

Until the beginning of the 1990s, the state of the�nancial sector in India could be described as a classicexample of ��nancial repression�. Strong entry barriersthwarted competition from new entrants. Capitalisationlevels were low due to lack of commercial considerationsin credit planning and weak recovery culture whichalso resulted in large accumulation ofnon-performing loans...The competition induced by thenew private sector banks has clearly re-energised theIndian banking sector as a whole. NPLs declinedsubstantially and consistently since the mid-1990s.- Rakesh Mohan, Deputy Governor of the Reserve Bankof India, 2004.


Bank entry is signi�cant

Pre-1991, banking sector dominated by government banks.

Post-1991, sector deregulated under argument thatcompetition would improve e¢ ciency.

Private BanksShare of Total Deposits in 1991 4.42%Share of Total Deposits in 2004 18.08%

State and Nationalized BanksShare of Total Deposits in 1991 85.96%Share of Total Deposits in 2004 74.07%

Foreign BanksShare of Total Deposits in 1991 7.24%Share of Total Deposits in 2004 4.37%

nagupta

Rectangle

Share of Total Deposits in 1991 4.42% Share of Total Deposits in 2004 18.08%


Why private bank entry may matter - Chennai o¢ ces ofIndia�s largest private bank

ICICI Bank in Chennai


And inside the Chennai o¢ ces of India�s largeststate-owned bank

Figure: State Bank of India, Chennai


Data

Banking data

Map bank entry using Reserve Bank of India data.Observe branches, deposits, and loans in each district by bankownership group.Bank ownership groups include government, private domestic,foreign, and rural regional banks.Data across India�s > 500 districts from 1991-2004.Match bank entry data by district to corporate bankruptcydata.


Bankruptcy data

Track bankruptcy �lings using hand-collected data.

Covers population of BIFR �lings from 1991-2004.

Includes date of �ling, net worth, accumulated losses,workforce, eventual outcome, date of exit.

Tells us where �rm�s headquarters are located.

We match corporate bankruptcy data to banking data by district


Summary statistics

Total Filings/Population

DismissedFilings

/PopulationSick Filings/Population

Mean 0.160 0.052 0.077St Dev (0.526) (0.184) (0.250)

N 7187 7187 7187

Workouts/Population

Liquidations/Population

Avg. Duration ofWorkouts and

Liquidations

Mean 0.037 0.041 1488.16Std Dev (0.128) (0.130) (674.54)

N 7187 7187 2560


Empirical Speci�cation

District-level panel data regression

Bankruptcy Outcomedt= β0+β1Bank Competitiondt+X dt+δt+αd+εdt

District and year �xed e¤ects; Standard errors clustered atdistrict level.

Bank competition variables: Private bank % share of deposits;Foreign bank % share of deposits

Xdt include district level time varying controls:

Log(GDP of State)Total Banks in districtTotal Loans in districtDistrict level �rm sales growthUrbanization


Private bank entry is associated with increase inbankruptcy �lings (Table IV)

Dependent Variable =Total Filings /

Population

DismissedFilings

/Population

Sick Filings/Population

Private Bank % of Deposits 0.041*** 0.016*** 0.001(0.009) (0.003) (0.002)

Foreign Bank % of Deposits 0.127 0.040 0.012(0.093) (0.029) (0.029)

Total Banks / Population 0.003** 0.001 0.001(0.001) (0.001) (0.001)

Log (State GDP) 0.099 0.062 0.081(0.129) (0.049) (0.063)

Year fixed effects X X XDistrict fixed effects X X X

Number of DistrictYears 7,187 7,187 7,187Number of Districts 565 565 565

nagupta

Rectangle

0.041*** 0.016*** 0.001 (0.009) (0.003) (0.002) 0.127 0.040 0.012


And a change in bankruptcy outcomes (Table V)

Dependent Variable = Workouts/ Population

Liquidations/ Population

Private Bank % of Deposits 0.006*** 0.006***(0.002) (0.001)

Foreign Bank % of Deposits 0.018 0.007(0.016) (0.022)

Number of DistrictYears 7,187 7,187Number of Districts 565 565

nagupta

Rectangle

0.006*** 0.006*** (0.002) (0.001)


Despite increase in �lings...delays decrease (Table VI)

Dependent Variable =

AverageDuration ofWorkouts &Liquidations

AverageDuration ofWorkouts

AverageDuration ofLiquidations

Private Bank % of Deposits 38.06** 26.10 42.83**(17.86) (33.41) (19.11)

Foreign Bank % of Deposits 24.64 43.781 42.39*(19.94) (28.72) (22.12)

Number of DistrictYears 489 136 423Number of Districts 185 69 165


Summary of �ndings

Private bank entry a¤ects creditor incentives to monitor loans andrecover assets faster.

Increased �lings may re�ect more aggressive lenders.

Debtors �ling for reorganization often do so becauseonce a court accepts the case, it usually puts theenforcement of claims of individual creditors on hold.This allows management and shareholders to gain time,often for legitimate reasons but sometimes to tunnelvaluable assets out of the company. - The World Bank,Doing Business, 2012.

Workouts may be quicker way to recover some value sinceliquidations can take 10-20 years more.Reduced duration (despite increased �lings) may re�ectwillingness of lenders to accept concessions.

Foreign banks less able to navigate courts?


Do creditor rights matter?

If �ndings re�ect creditor incentives, we expect them to vary basedon creditor rights.Use introduction of Debt Recovery Tribunals (DRT) as shock to�creditor rights�

Tribunals were set up to streamline procedures.

Establishment of DRTs was staggered across states and timefrom 1994-1999 because of legal �ghts.

DRT doesn�t prevent �rm from seeking BIFR stay.


Creditor rights in combination with bank entry appearimportant (Table VIII)

Dependent Variable = Total Filings /Population

DRT in State 0.008(0.025)

Private Bank % of Deposits 0.024***(0.008)

DRT in State * Private Bank % of Deposits 0.005**(0.003)

Foreign Bank % of Deposits 0.092**(0.038)

DRT in State * Foreign Bank % of Deposits 0.182***(0.021)

Bank entry and bankruptcy �lings associations are stronger inregions with stronger creditor rights. Foreign banks now matter.


Alternative channels #1

Are results driven by change in supply of credit?

Increase in overall supply of credit might reduce bankruptcies;do not �nd that, and we control for total loans in district.

Increase in supply of credit may increase product marketcompetition leading to more exits by weaker �rms; do not �ndthat.

Reduced �nancial access for opaque, riskier, or less pro�table�rms would increase number of distressed �rms; do not �ndthat.

Supply of credit channel does not explain decrease in durationand creditor rights results.


Controlling for supply of credit (Table X)


Alternative channels #2

Bank entry may shift allocation of credit to di¤erent �rms (wherebankruptcy more easily resolved)?

If �rms are di¤erent, why is there no change in # of sick�rms?

Also does not explain frivolous �lings, creditor rights results.

Examine whether bank enty changes the characteristics of�rms �ling for bankruptcy.

Control for �rm-level characteristics in robustness checks.


Does bank entry a¤ect the characteristics of bankrupt�rms?

Dependent Variable = Ln(Sales) PBDT/Assets Debt/Assets

BankDebt/Asset

s

InterestPayments/Asse

ts

Ln(AverageNet Worth)

Ln(AverageAccumulated

Losses)

Ln(AverageNumber ofWorkers)

Private Bank % of Deposits 2.1509 1.0066 1.5597 0.0418 0.0758 0.007 0.011 0.001(0.646) (0.423) (0.249) (0.942) (0.785) (0.016) (0.016) (0.014)

Total Banks / Total Firms 0.0173 0.0002 0.0107* 0.0025 0.0001 0.012 0.005 0.017(0.385) (0.962) (0.098) (0.145) (0.957) (0.033) (0.023) (0.018)

Log (State GDP) 1.8605 0.2575 0.3667 0.1466 0.1223** 0.002 0.005 0.005(0.268) (0.169) (0.407) (0.557) (0.023) (0.003) (0.004) (0.004)

Year fixed effects X X X X X 0.704 0.393 0.140District fixed effects X X X X X (0.686) (0.709) (0.500)Number of Firms 641 657 657 657 657 X X XRsquared 0.259 0.081 0.251 0.271 0.133 X X X


Controlling for �rm characteristics

Total Filings/Population

DismissedFilings


Workouts/Population

Liquidations/Population

AverageDuration

Private Bank % of Deposits 0.940 0.4004 0.189 0.1982 0.0088 3063.577(0.2601)** (0.1770)* (0.0888)* (0.0508)** (0.057) (1,529.7731)*

Average Accumulated Losses 0.002 0.004 0.006 0.0021 0.004 43.688(0.005) (0.003) (0.0028)* (0.002) (0.0019)* (93.975)

Average Net Worth 0.008 0.000 0.008 0.005 0.003 74.735(0.0038)* (0.002) (0.0025)** (0.0021)* (0.002) (88.111)

Average Number of Workers 0.009 0.002 0.000 0.001 0.001 146.280(0.0040)* (0.002) (0.002) (0.002) (0.002) (59.1660)*

Number of DistrictYears 1,016 1,016 1,016 1,016 1,016 537Number of Districts (250) (250) (250) (250) (250) (194)

Panel B


Identi�cation concerns

Omitted variable bias possible if bank entry correlated totime-varying factors related to bankruptcy, i.e. results may bedue to omitted variables such as bank entry into high growthdistricts or districts with more non-performing loans.

Simultaneity bias possible if bankruptcy outcomes a¤ectbank entry choices.


Identifying impact of bank entry #1

Possible bias #1: Bank entry is related to growth prospects, whichis related to increased �rm exits?

But, �ndings seem robust to various controls. . .

State-level GDP growthDistrict-level growth in loans (Log total loans)Urban-year �xed e¤ects.State-year �xed e¤ects.Growth in aggregate �rm-level sales at the district level.

Growth story inconsistent with no increase in distressed �rms.

Does not explain duration or other results.


Controlling for State and District Growth


Private Bank % of Deposits 0.041*** 0.035*** 0.039***(0.011) (0.011) (0.013)

Log (State GDP) 0.120(0.135)

Log (Total Loans in District) 0.010(0.052)

Year fixed effects X X XDistrict fixed effects X X XUrbanyear fixed effects XStateyear fixed effects XNumber of DistrictYears 7,187 7,187 7,187Number of Districts 565 565 565

Total Filings / Population


Identifying impact of bank entry #2

Possible bias #2: Bank entry is greater where incumbent banks areburdened with political NPLs?

But, size of private bank entry is unrelated to share ofgovernment deposits prior to their entry.

And, �ndings are robust to proxies for �political loans�.

Also can�t explain other results.


Controlling for political loans


Private Bank % of Deposits 0.075*** 0.075*** 0.075***(0.018) (0.018) (0.018)

% of Borrowings by Gov't Firms 0.174(0.176)

% of Sales by Gov't Firms 0.0533(0.187)

Log (Firm Sales in District) 0.015(0.017)

Number of DistrictYears 2,470 2,506 2,549Number of Districts 238 241 242



Identifying direction of relationship

Simultaneity bias: Bankruptcies weaken incumbent banks andfacilitate entry of new, private banks?

Why would a shift to workouts, or reduced duration be subjectto such a bias?

Adding leads & lags, we �nd bankruptcy �lings are related tolagged bank entry.


Bankruptcy �lings related to lagged bank entry

Dependent Variable =Private Bank % of Deposits [t+1] 0.012 0.010 0.012

(0.009) (0.009) (0.009)Private Bank % of Deposits [t] 0.037*** 0.006 0.003

(0.010) (0.009) (0.009)Private Bank % of Deposits[t1] 0.045*** 0.027**

(0.016) (0.012)Private Bank % of Deposits [t2] 0.033***

(0.009)Number of DistrictYears 6,643 6,088 5,533Number of Districts 565 565 558Rsquared 0.67 0.68 0.70



Implications

It isn�t just bankruptcy law that matters.

Provide an explanation as to why bankruptcy outcomes mayvary within a legal framework.

Di¤use lending relationships can a¤ect use of bankruptcy(Gilson, John, and Lang, 1990).Biases of bankruptcy judges can a¤ect outcomes (Chang andSchoar, 2007).

Suggests another impact of banking sector competition

Competition may increase �nancing constraints (Petersen andRajan, 1995) or increase access to credit (Guiso, Sapienza, andZingales, 2007), reduce bad loans, increase economic growth(Jayaratne and Strahan, 1996, Cetorelli and Gambera, 2001).Increase product market competition and reduce subsidies tobad �rms (Bertrand, Schoar, and Thesmar, 2007).Our study suggests that banking sector entry may a¤ectcorporate bankruptcy outcomes.


Concluding remarks

E¤ect of bank entry on bankruptcy outcomes not previouslyconsidered in literature

Evidence suggests creditor incentives may matter. . .

Duration, outcomes, and frequency related to entryAssociation is larger when creditor rights improve

Uncompetitive banking sectors may contribute to ine¢ ciencyof bankruptcy systems

Reforms that focus on changes in bankruptcy law should takeinto account local �nancial market characteristics.


Increase in bank competition is associated with increase incorporate bankruptcy �lings

Dependent Variable = Total Filings/Population

DismissedFilings


1 HH1 of Deposits 1.237*** 0.521*** 0.111(0.414) (0.179) (0.136)

Number of DistrictYears 7,187 7,187 7,187Number of Districts 565 565 565Rsquared 0.66 0.41 0.48

Corporate Bankruptcy and Bank Competition · Motivation Background Data Regression results...

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