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IntroductionIntroduction
There is a dramatic rise in the number of firms filing for chapter- 11bankruptcy which
led to main concern for economists to understand how financial distress affects
allocation of resources. The Current structure of this bankruptcy code allows
incumbent management to retain control of firm in bankruptcy and gives management
exclusive right to propose a plan of reorganization. Critics of Chapter 11 argues that theprocess is biased toward reorganization rather than liquidation. In this scenario, it felt
important to examine whether there are economically important biases toward
continuation of unprofitable firms. The results also suggests that managements role in
the chapter 11 process may be an important source of bias. There are other factors
outside of managements control that affect subsequent performance.
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Trends in ManagementTrends in Management
During BankruptcyDuring Bankruptcy Over Half of the Sample Firms in the analysis have replaced their CEOs in office
2 years before filing by the time a plan of reorganization is proposed.
70 % of the Firms have replaced their CEO by the time a reorganization plan isimplemented after bankruptcy.
It was observed that , The continued involvement of original management in the
restructuring process is strongly associated with poor bankruptcy performance. Firms
are also likely to perform worse than projected at the time of reorganization when
original management remains in office during Bankruptcy.
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Theoretical ModelsTheoretical Models
These Models suggest why chapter 11 may facilitate the rescue of inefficient firms
Bulow and Shoven
They Considers reorganization over liquidation choice of firms in financial distressshow how risk shifting incentives of lower priority claimants can lead to excessive
continuation of investment.
Gertner and Scharfstein
They argues that key provisions of Chapter 11 reorganization law , such as automatic
stay , chapter 11 voting , and maintanance of equity value in reorganized firm lead toincreased investment.
White
He states that Chapter 11 decreases the probability that economic efficient firms shut
down , it increases the probability that economic inefficient firms continue to operate.
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Theoretical Models(Contd.)Theoretical Models(Contd.)
Mooradian
He states that Large number of firms choosing reorganization under chapter 11 are
economically inefficient.
Bradley and Rosenzweig
They argues that management has too much power in chapter 11 and they exercise this
power in self serving manner.
Based on these models , Chapter 11 increases investment but may lead to
overinvestment if firms that should be liquidated are reorganized. Also, the poorinvestment decisions made in bankruptcy are reflected in the postbankruptcy
performances of firms emerging from the process.
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Trends of CompaniesTrends of Companies whowho
filedfiled chapter 11chapter 11 Out of the firms those plan for reorganization was confirmed , 197 emerged from
bankruptcy as public companies that continued to file financial statements with
Securities and exchange commission.
The companies that emerged public has greater book value of assets , they have
higher revenue than the other companies in observation. Although the months in
bankruptcy is same for all the samples.
For the sample survey , the data was obtained from the plan of reorganization and
disclosure statements and also from 8-k and 10-k reports if possible.
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Success after BankruptcySuccess after Bankruptcy
Postbankruptcy performance of the 197 firms that emerged from chapter 11 as
public companies is evaluated using three different measure
Accounting measures of profitability.
Whether firm meets cash flow projections at the time of reorganization.
Whether the reorganized business needs to restructure again through a private
workout or secondary bankruptcy.
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Success afterSuccess after
Bankruptcy(contd.)Bankruptcy(contd.)Accounting Measures of postbankruptcy performance helps to identify improvement in
firm performance following leveraged buyouts , management buyouts or mergers. Based
on the changes in total assests , revenues , employees and operating income , many
firms increase in size after bankruptcy although they show positive growth butprofitability does not show strong increase in post bankruptcy period.
In the firms where CEO s are retained there will be incentives from the management
side which may lead to lower performance of the firms . Although the firms that have
their CEO replaced show better operating incomes that previous ones. However , half
of the firms carry operating losses for the next 3 years of bankruptcy.
The reasons that management cite at the time of second filing varies , some emerges
saying they have too much debt, half of the firms state the primary reason of their first
filing and many says that adequate corrective measures were not done at the first time.
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ConclusionsConclusions
The results shows that large number of firms that emerge either are not viable or
soon require further restructuring.
The results shows that there are economic biases toward reorganization under thecurrent structure of chapter 11.
It also comes out that the firms retaining prebankruptcy management is strongly
related to worse postbankruptcy performance.
Firms often fail to meet cash flow projections prepares at the time of
reorganization, particularly when prebankruptcy management remains in officethrough the time the projections were made.
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