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Bankruptcy resolution: Direct costs and violation of priority of claims
Abstract
I present new evidence on the direct costs of bankruptcy and violation of priority of claims. In a sample of 37 New York and American Stock Exchange firms that filed for bankruptcy between November 1979 and December 1986, direct costs average 3.1% of the book value of debt plus the market value of equity, and priority of claims is violated in 29 cases. The breakdown in priority of claims occur primarily among the unsecured creditors and between the unsecured creditors and equity holders. Secured creditors' contracts are generally upheld.
... In part due to violation of the absolute priority rule (APR) and other "me-first" rules (e.g. Franks and Torous (1989) and Weiss (1990)) and in part due to coordination problems among creditors with heterogeneous preferences over restructuring plans, there is considerable room for bargaining among different stakeholders. Such bargaining and 1 Franks and Torous (1989) document that the average bankruptcy takes 2.7 years, whereas Weiss (1990) estimates it to be 2.5 years. ...
... Franks and Torous (1989) and Weiss (1990)) and in part due to coordination problems among creditors with heterogeneous preferences over restructuring plans, there is considerable room for bargaining among different stakeholders. Such bargaining and 1 Franks and Torous (1989) document that the average bankruptcy takes 2.7 years, whereas Weiss (1990) estimates it to be 2.5 years. Bris, Welch, and Zhu (2006) examine smaller firms and find that the average Chapter 11 proceeding takes 2.3 years. ...
... Variations required in the implementation of bank resolution to liquidation, open-bank assistance (OBA), open market and so on average settlement take 5 years, according Mason [14] and while average 12.5 years in Warner [15], or average to 2.5 years by Weiss [16]. Bank failures can cause a major upheaval for a large number of individuals and businesses when they cannot instantly access funds, make payment transactions, or withdraw credit [17] and the time required to resolve legal issues will take longer [18]. ...
... This is in line with the results of interviews for three Heads of LT and Mr YA. The liquidation time of failed banks of Indonesia is no different from other countries according to Mason [14] research, and the majority of cases of liquidation are resolved average to 2.5 years Weiss [16]. ...
Bank liquidation is one method of bank resolution conducted by resolution authority. The bank's resolution occurs when the authority
establishes a bank declared/tends to fail and there is no private sector intervention that can restore the bank's ability in a short time for
normal procedures. This study aims to explain the application of liquidation on rural banks liquidated by Deposit Insurance Corporation.
Indonesia (IDIC) as well as its implications for recovery rate and residual assets resulting from the liquidation process. The methodology in
this research is qualitative and the nature of this research is descriptive analysis. The authors used two different types of sources. First,
direct observations to IDIC office. Second, Semi-structured interviews were conducted with the chairman of liquidation team of rural
banks, the official of IDIC and Auditors who engage audit on or attestation on the liquidated bank, which time informal interviews were
conducted, and documents were also collected. Based on the result of this research, it is concluded that with the implementation of
liquidation method, there are critical issues that require IDIC attention, such as the fraud rate that occurred before the bank was liquidated,
time of submission of problem banks from Bank Supervisory Authority (BSA) to IDIC, and decrease of asset quality and flow of
documentation and information of failed bank, personnel readiness, supervision, handling of liquidation assets and limitations of
liquidation guidelines. The critical problem faced above will ultimately affect the recovery rate and residual assets after the liquidation
process ends.
... In part due to violation of the absolute priority rule (APR) and other "me-first" rules (e.g. Franks and Torous (1989) and Weiss (1990)) and in part due to coordination problems among creditors with heterogeneous preferences over restructuring plans, there is considerable room for bargaining among different stakeholders. Such bargaining and 1 Franks and Torous (1989) document that the average bankruptcy takes 2.7 years, whereas Weiss (1990) estimates it to be 2.5 years. ...
... Franks and Torous (1989) and Weiss (1990)) and in part due to coordination problems among creditors with heterogeneous preferences over restructuring plans, there is considerable room for bargaining among different stakeholders. Such bargaining and 1 Franks and Torous (1989) document that the average bankruptcy takes 2.7 years, whereas Weiss (1990) estimates it to be 2.5 years. Bris, Welch, and Zhu (2006) examine smaller firms and find that the average Chapter 11 proceeding takes 2.3 years. ...
... Only paths that do not fall below level B d and also end up above the strike F, i.e., face value of the total liabilities, at terminal time T generate positive payoffs to equity, assuming an absolute priority rule. Weiss (1990) showed that the absolute priority rule of claims is rarely followed in practice as equity holders usually receive some compensation during bankruptcy and senior creditors are normally not fully paid. Hence, in this paper, we assume the absolute priority rule is not strictly followed. ...
We implemented a methodology to calibrate capital structure models for banks that have issued contingent convertible securities (CoCos). Typical studies involving capital structure model calibration focus on non-financial firms as they have lower leverage and no contingent convertible securities. From a theoretical perspective, we found that jumps in the asset value process were necessary to obtain a satisfactory fit to the market data. In practice, contingent capital conversion triggers are discretionary, and there is considerable uncertainty around when regulators are likely to enforce conversion. The market-implied conversion triggers we obtain indicate that the market expects regulators to enforce conversion while the issuing bank is a going concern, as opposed to a gone concern. This fact is presumably of interest to potential dealers, regulators, issuers, and investors.
... It may include loss of market share and reputation, rise of the cost of capital, loss of favorable trade credit terms from supplier, loss incurred from selling assets at distressed fire-sale prices, the departure of valuable human capital, and an exposure to competitor's aggressive strategy. It begins in Warner (1977) and Weiss (1990) who document the estimate costs range from 3% to 5% of firm value at the time of distress. Altman (1984) reports that firms can lose 11% to 17% of firm value 3 years prior to bankruptcy. ...
This paper examines whether innovation ability improves corporate performance of financially distressed firms. I begin by providing direct evidence that innovative firms in financial distress have significantly better future operating performance. To identify the causal effect, I study an exogenous shock—State Street Bank and Trust Company v. Signature Financial Group, Inc.—and find that an increase in innovation ability causes an improvement in future performance of distressed firms. Financial markets tend to pay more attention to innovative distressed firms, but these firms do not earn abnormal equity returns than their counterparts. I document that average investors hold pessimistic perspectives on distressed firms with innovation ability. In contrast, institutional investors have contrarian beliefs on distressed firms with innovation ability and hold more shares in these firms.
... Some works suggest that the judicial discretion provided to bankruptcy judges can affect the outcome of the bankruptcy process. For instance, Weiss (1990) discusses as equity holders seem to obtain a better treatment when bankruptcy litigations are administered in New York rather than in California, Massachusetts, Florida, Michigan, Illinois and Ohio; Blazy et al. (2011) show that, in line with the provisions of the French bankruptcy code, 33 judges tend to privilege bankruptcy outcomes safeguarding the employment even if this may be detrimental for the debt recovery rates. Yet, the French bankruptcy context is quite different from the Italian one, as the decision on the adoption of the plan is a court's prerogative, whereas in Italy the decision rests on a creditors' vote. ...
The paper investigates the complementary role of hard and soft information in affecting the bankruptcy outcome of in-court procedures. Previous literature mostly focuses on hard information as driver of the bankruptcy outcome. In a bankruptcy context, we identify the causes of default as a key piece of soft information which can emerge through a textual analysis of the legal papers written by the insolvency practitioners. We posit that soft information complements hard information in guiding creditors’ choice of the bankruptcy outcome. To test our hypotheses, we construct a unique dataset composed of hard and soft information of Italian Small and Medium Enterprises that faced in-court debt renegotiation between 2011 and 2016. We show that the role of hard information in guiding creditors’ decisions depends on the specific cause of default they interact with and we conclude that the two sets of information jointly shape the conditions for the bankruptcy outcome.
... Second, unlike Cooper and Nyborg (2018), we estimate the value of expected bankruptcy costs using the risk probability of default and the present value of bankruptcy costs (see Damodaran 2012). This method aligns with a significant body of literature that calculates the risk probability of default (e.g., Altman 1968; Altman and Hotchkiss 2006; Altman et al. 2017) 5 and the present value of bankruptcy costs, while also providing empirical evidence about the direct and indirect costs of bankruptcy (e.g. , Warner 1977;Weiss 1990;Branch 2002). This approach ensures that our formulae are easy to apply in practice. ...
This study introduces a new version of the adjusted present value (APV) method and ensures its consistent valuation with the cost of capital (CoC) method at the highest level of generalization. The newly developed APV version and equivalent formulae consider stochastic debt and the trade-off between corporate income taxes (CIT) and personal income taxes (PIT), as well as tax benefits and financial distress costs. The value of expected bankruptcy costs aligns with the valuation aspect, enabling practical application of the formulae by valuers. The equivalence also reflects the differing perspectives of tax shields between stockholders and debt holders when PITs are introduced. Ultimately, the results demonstrate that the equivalence in this study aligns with, and can reduce to, previous standard formulae, under their stringent assumptions.
... The eddies are identified based on their strong rotational characteristics, accompanied by convergence and divergence motions, which correspond to a positive (negative) sea level anomaly (SLA) within anticyclonic (cyclonic) eddies [41]. There are several mesoscale eddy identification methods, including closed contour [40], Okubo-Weiss (OW) [42,43], winding angle (WA) [44] and the vector geometry-based eddy detection algorithm (VG) [45]. Among these, the VG method identifies the eddy boundary based on the outmost contour of stream function. ...
The Drake Passage is known for its abundant mesoscale eddies, but little is known about their three-dimensional characteristics, which hinders our understanding of their impact on eddy-induced transport and deep-sea circulation. A 10-year study was conducted using GLORYS12 Mercator Ocean reanalysis data from 2009 to 2018. The study analyzed the statistical characteristics of eddies in the Drake Passage, spanning from the surface down to a depth of 2000 m in three dimensions. The findings indicate that the mean radius of the eddies is 35.5 km, with a mean lifespan of 12.3 weeks and mean vorticity of 2.2 × 10−5 s−1. The eddies are most active and energetic near the three main fronts and propagate north-eastward at an average distance of 97.8 km. The eddy parameters vary with water depth, with more anticyclones detected from the surface to 400 m, displaying a larger radius and longer propagation distance. Cyclones have longer lifespans and greater vorticity. However, beyond 400 m, there is not much difference between anticyclones and cyclones. Approximately 23.3% of the eddies reach a depth of 2000 m, with larger eddies tending to penetrate deeper. The eddies come in three different shapes, bowl-shaped (52.7%), lens-shaped (27.1%) and cone-shaped (20.2%). They exhibit annual and monthly distribution patterns. Due to its high latitude location, the Drake Passage has strong rotation and weak stratification, resulting in the generation of small and deep-reaching eddies. These eddies contribute to the formation of Antarctic intermediate water and lead to modulation of turbulent dissipation.
... The indirect bankruptcy costs are apparent in the loss of reputation, important customers and employees as well as the potential loss due to a fire sale of assets or an inefficient liquidation process. Various empirical studies concerning direct bankruptcy costs have been published, for example Baxter (1967); Warner (1977); Altman (1984); Weiss (1990); Betker (1997); Lubben (2000); Thorburn (2000) and LoPucki and Doherty (2004). These studies show average values between 2 and 7% for large companies, depending on the sample examined. ...
In this paper, we revisit a frequently employed simplification within the WACC approach that company cost of capital $$k_{V}$$ k V is supposed to be invariant to the debt ratio and therefore equal to the unlevered cost $$k_{U}$$ k U . Even though we know from Miles and Ezzell (1980) that $$k_{V}$$ k V formally differs from $$k_{U}$$ k U , treating both costs as equal strongly facilitates the practical firm valuation e.g. when companies strategically change their target debt ratios to a significantly different magnitude after a transaction. We provide both a theoretical model and an empirical analysis using 29 firms of the German stock market to quantify the economic significance between the company cost of a levered and an otherwise identical but unlevered firm. In particular, we can numerically support the usual simplification in the absence of default risk. In case that firms are default-risky, however, empirical findings indicate a clear difference between these costs equal to 1.88 percentage points on average even for moderate assumed bankruptcy costs which translates to a company mispricing of nearly 100%. As a result, the company cost of capital does practically not depend on the debt ratio if the firm is not subject to default risk or if bankruptcy costs are negligible. Otherwise, it does and a negligence of this relationship can cause significant mispricings.
... We chose to express bankruptcy costs as a fraction of the firm value before bankruptcy as it is usually done both in theoretical [Leland, 1994] and empirical studies [Altman, 1984, Weiss, 1990. The various approaches only differ on the measures of the firm value (book versus market value, total versus equity value), in the model, we choose the market operational value of the company. ...
This thesis focuses on the development of a mathematical model and optimization algorithms for the design of a supply chain integrating financial dimensions. We propose a capacitated, multi-period, single-echelon, single-product model. The objective function to be maximized is the firm's value, represented by its Adjusted Present Value (APV). The decision binary variables are related to the location of logistics facilities; the continuous variables concern product flows and debt planning. The mathematical model is first evaluated by solving a set of generated instances using a state-of-the-art solver. We propose a sequential approach, consisting in optimizing the logistic variables first, then the financial variables. Then, we propose an optimization procedure based on the Large Neighborhood Search (LNS) metaheuristic to solve larger instances. Finally, consider the logistic and financial dimensions as two independent objectives. The multi-directional local search (MDLS) is employed to solve the bi-objective model by embedding the LNS into that framework. Extensive numerical experiments assess the relevance of our model and compare the performance of our algorithms to those of the solver.
... The establishment of such a body seems to have been due to the historical period of development of the country as a whole, when, as a result of the transition from one economic system to another, the vast majority of enterprises previously receiving significant funds from the state, as a result of their inability to participate in market relations came to financial collapse without this support. In such a situation, the state, through the creation of the above service, was striving to rectify the situation and, if possible, to ensure the financial recovery of at least the largest enterprises where the state was present as the owner or founder [11]. ...
The purpose of this work is to determine the essence of pre-trial prevention of insolvency of an economic entity, consider the content of this phenomenon, and study its use in order to prevent the existing negative consequences of insolvency proceedings in the economy. The methodological basis of the study comprises the general scientific dialectical method of cognition, which allows considering the institutions of law in the relationship, integrity, and development. Special and specific scientific methods are used: historical and legal, formal and logical, the method of comparative law. In order to achieve this result, the following more specific tasks are proposed: to determine the place of pre-trial prevention of insolvency of an economic entity within the framework of the institution of insolvency; to isolate the structure of the phenomenon of pre-trial prevention of insolvency; to determine the essence of the specific aspects of pre-trial prevention of insolvency; to analyze the features of individual procedures and develop proposals for the legal regulation of their conduct; to develop proposals to improve domestic insolvency law in order to ensure the possibility of preventing the negative consequences of bankruptcies in the pre-trial stages. Based on foreign experience, it is proposed to regulate the activities of domestic entrepreneurs in the field of pre-trial prevention of insolvency of economic entities at the legislative level.
... In this paper, we investigate what role bank shareholding plays when firms are in financial distress other than in normal times, a topic that has not been addressed in prior literature. Given the lower costs of out-of-court debt restructuring relative to those of outright bankruptcy liquidation (Gilson, John, and Lang 1990;Weiss 1990;Tashjian, Lease, and McConnell 1996), and the financial flexibility of restructuring (Boot 2000), a debt restructuring is an ideal pursuit for distressed firms than liquidation. Thus, we are interested to know whether bank shareholding facilitates or impedes debt restructuring relative to the circumstance when banks are only creditors. ...
This paper investigates the impact of bank shareholding on corporate debt restructuring. Using a sample of financially distressed firms in China from 2007 to 2016, we find that distressed firms with bank shareholders are more likely to restructure their debt than firms without bank shareholders. Moreover, the alleviation of renegotiation friction in both distressed state-owned enterprises (SOEs) and non-state-owned enterprises (non-SOEs) and reducing information asymmetry in non-SOEs facilitate the positive impacts of bank shareholding on debt restructuring. In addition, the impact is more evident in distressed non-SOEs characterized by higher profitability prior to restructuring. Further, distressed non-SOEs with bank shareholders are more likely to recover from distress than their peers, while the results are opposite for distressed SOEs. We argue that while bank shareholding facilitates restructuring in distressed non-SOEs, it aggravates the soft budget constraint in troubled SOEs. Our results are robust after accounting for the selection bias of bank shareholding.
... empirical literature on Chapter 11 distinguishes two types of APR violations (see, e.g.,Weiss, 1990, Tashjian et al., 1996, Capkun and Weiss, 2016: The …rst type of APR violation (type I) occurs when senior creditors recover less than the nominal value of their claim while junior creditors receive a non-trivial payo¤, that is, when! R s (v; c) < cs r and ! ...
A redemption option granted to junior creditors has been advocated to accelerate Chapter 11 negotiations and rebalance junior recovery with respect to senior claims. We develop a game-theoretic, continuous-time model of the leveraged firm under Chapter 11 to assess the wealth transfers and welfare impacts of such an amendment to the bankruptcy procedure. After fitting the model to Chapter 11 current outcomes, we show that the redemption option design overcompensates junior creditors, leading to different, but not less frequent, Absolute Priority Rule violations. Since the reform shifts negotiations from a three- to a two-player game, it reduces the scope for concessions in the bargaining process and raises the risk of liquidation. Importantly, the redemption option aligns junior creditors’ interests with those of shareholders, thereby increasing the incentives for risk-shifting prior to bankruptcy.
https://doi.org/10.1016/j.irle.2021.106005
... In part due to violation of the absolute priority rule (APR) and other "me-first" rules (e.g. Franks and Torous (1989) and Weiss (1990)) and in part due to coordination problems among creditors with heterogeneous preferences over restructuring plans, there is considerable room for bargaining among different stakeholders. Such bargaining and 1 Franks and Torous (1999) document that the average bankruptcy takes 2.7 years, whereas Weiss (1996) estimates it to be 2.5 years. ...
This paper analyzes the costs and benefits of a no-fault-default debt structure as an alternative to the typical bankruptcy process. We show that the deadweight costs of bankruptcy can be avoided or substantially reduced through no-fault-default debt, which permits a relatively seamless transfer of ownership from shareholders to bondholders in certain states of the world. We show that potential costs introduced by this scheme due to risk shifting can be attenuated via convertible debt, and we discuss the relationship of this to bail-in debt and contingent convertible (CoCo) debt for financial institutions. We then explore how, despite the advantages of no-fault-default debt, there may still be a functional role for the bankruptcy process to efficiently allow the renegotiation of labor contracts in certain cases. In sharp contrast to the human-capital-based theories of optimal capital structure in which the renegotiation of labor contract in bankruptcy is a cost associated with leverage, we show that it is a benefit. The normative implication of our analysis is that no-fault-default debt, when combined with specific features of the bankruptcy process, may reduce the deadweight costs associated with bankruptcy. We discuss how an orderly process for transfer of control and a predetermined admissibility of renegotiation of labor contracts can be a useful tool for resolving financial institution failure without harming financial stability.
... Another way to understand contagion is through sensitivity of the Eisenberg-Noe calculations [28,33]. Our model is static, in contrast to [7], and we do not address priorities of claims [35]. ...
The problem of analyzing interconnectedness is one of today’s premier challenges in understanding systemic risk. Connections can both stabilize networks and provide pathways for contagion. The central problem in such networks is establishing global behavior from local interactions. Jiang-Lim-Yao-Ye (Jiang et al 2011 Mathematical Programming 127 1 203–244) recently introduced the use of the Hodge decomposition (see Lim 2020 SIAM Review 62 685–715 for a review), a fundamental tool from algebraic geometry, to construct global rankings from local interactions (see Barbarossa et al 2018 (2018 IEEE Data Science Workshop (DSW), IEEE) pp 51–5; Haruna and Fujiki 2016 Frontiers in Neural Circuits 10 77; Jia et al 2019 (Proc. of the XXV ACM SIGKDD International Conf. on Knowledge Discovery & Data Mining , pp 761–71 for other applications). We apply this to a study of financial networks, starting from the Eisenberg-Noe (Eisenberg and Noe 2001 Management Science 47 236–249) setup of liabilities and endowments, and construct a network of defaults. We then use Jiang-Lim-Yao-Ye to construct a global ranking from the defaults, which yields one way of quantifying ‘systemic importance’.
The performance of non-life insurers is essential to the economy because of their role in mitigating the risks firms and households face. This study provides a comprehensive overview of studies examining factors affecting non-life insurers’ performance. Based on 235 studies published between 1990 and 2021, the review demonstrates that firm-level factors such as size, organisational form, diversification, capital structure, risk, reinsurance, corporate governance, distribution system, and group affiliation, and external factors such as market structure, macroeconomic, financial, and institutional development are the major determinants of non-life insurers’ performance. Although the empirical evidence on the effect of these factors is generally mixed, firm size, capitalisation, risk, macroeconomic conditions, and, to some extent, corporate governance and market structure issues show a clear relationship with insurer performance. One of the implications of this study is that there may be a need for increased solvency surveillance, especially for smaller insurers, which appear to have a higher risk of insolvency than their larger counterparts.
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)
Corporate bankruptcy and financial distress prediction is a topic of interest for a variety of stakeholders, including businesses, financial institutions, investors, regulatory bodies, auditors, and academics. Various statistical and artificial intelligence methodologies have been devised to produce more accurate predictions. As more researchers are now focusing on this growing field of interest, this paper provides an up-to-date comprehensive survey, classification, and critical analysis of the literature on corporate bankruptcy and financial distress predictions, including definitions of bankruptcy and financial distress, prediction methodologies and models, data pre-processing, feature selection, model implementation, performance criteria and their measures for assessing the performance of classifiers or prediction models, and methodologies for the performance evaluation of prediction models. Finally, a critical analysis of the surveyed literature is provided to inspire possible future research directions.
Purpose – The purpose of this paper is to examine whether managers of bankrupt firms are more or less
conditionally conservative in their financial reporting relative to non-bankrupt firms. The study further
examines the cross-sectional differences in conditional conservatism among bankrupt and non-bankrupt firms.
Design/methodology/approach – The study employs a sample of US firms to investigate conditional
conservatism in firms that experience financial distress and go bankrupt relative to non-stressed non-bankrupt
firms. The study also uses switching regression models to identify the drivers of the cross-sectional difference
in conditional conservatism among bankrupt and non-bankrupt firms.
Findings – Empirical results show that bankrupt firms are timelier in recognizing bad news than good news
when compared to non-bankrupt firms. The higher level of conditional conservatism in bankrupt firms is
mainly driven by their higher levels of leverage and tax-reduction incentives. The cross-sectional analyses
show that these results largely hold for more leveraged firms and firms with higher tax costs. Taken together,
these results suggest that the conservative tendency of managers of bankrupt firms can stem from the agency
problem between lenders and managers and from tax-decreasing motivations.
Originality/value – The novelty of the authors’ research stands in studying the drivers of the cross-sectional
differences in conditional conservatism between bankrupt and non-bankrupt firms and specifically, the
demonstration that taxation also induces conditional conservatism in the setting of ex post bankrupt firms.
For a long time, insolvency proceedings were understood as a special civil law procedure with the aim of maximizing creditor satisfaction. To the extent that public interests played a role in this, it was a matter of giving preferential treatment to particular groups of creditors. This was expected to contribute to the realization of sociopolitical values. For good reasons, such values are receiving less and less consideration in insolvency law. Instead, it has been recognized that proper structuring of the legal relationship between the debtor company and its creditors is likely to minimize macroeconomic damage in the public interest. This has led to a substantial change in the objectives of insolvency law, which – especially thanks to the Restructuring Directive (2019/1023/EU) – has arrived in all European legal systems. This article traces the paradigm shift and shows, using the example of German and Polish insolvency law, that despite having its foundations in European law, it has not yet been fully internalized in the legal systems of all Member States.
The share of secured debt issued (as a fraction of total corporate debt) declined steadily in the United States over the twentieth century. This stems partly from financial development giving creditors greater confidence that high‐quality borrowers will respect their claims even if creditors do not obtain security upfront. Consequently, such borrowers prefer retaining financial flexibility by not giving security up front. Instead, security is given contingently–when a firm approaches distress. This also explains why, superimposed on the secular decline, the share of secured debt issued is countercyclical.
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The life insurance industry plays a crucial role in the economy as it serves as one of the channels through which countries mobilize long-term savings, promote the development of capital markets, foster efficient capital allocation, and substitute and complement government security programs. Therefore, the performance of this sector is imperative. Since the early 1990s, researchers have been paying particular attention to the performance of life insurance firms, with a specific emphasis on identifying the key determinants of their performance. The objective of this study is to synthesize the studies that have explored this topic. Using a systematic literature review approach, the study reviews 129 studies published between 1990 and 2021. The analysis reveals that the literature primarily examines factors such as size, organizational structure, capital composition, diversification, distribution systems, risk management practices, and reinsurance strategies as key firm-specific drivers of life insurer performance. Additionally, the study underscores the importance of competition and macroeconomic conditions as commonly discussed external determinants. While a clear relationship between performance and factors like firm size, organizational structure, and risk management practices is evident, the impact of other factors remains inconclusive. One of the implications of this study is that policymakers should enact laws that promote competition in the insurance industry. The study also reveals several research gaps, including methodological gaps.
This chapter extends ► Chap. 15 by considering a different valuation approach—the adjusted present value (APV). Unlike the cost of capital (CC) approach, the APV approach determines firm value by splitting it into two components: value of the unlevered firm and value of the leverage effect. Except for considering leverage separately, other valuation aspects are not different from the CC approach: single-stage or multistage models can be applied in the same way on free cash flow to the firm (FCFF).
Financial distress is a condition in which a company or individual cannot generate revenue or income because it is unable to meet or cannot pay its financial obligations. This is generally due to high fixed expenses (like overhead or salaries), illiquid assets, or revenues sensitive to economic downturns. Firms with rising distress costs not only face potential bankruptcy but also a loss of profitability as management becomes preoccupied with darkening financial picture. Employees show lower productivity as they worry about their jobs; suppliers charge more money upfront for goods and services rather than invoicing or extending credit, and customers search for healthier companies to do business with. In this sense, distress costs can lead to a vicious cycle, deepening the degree of distress. There are methods or techniques that a company can use to reduce its overall risks and these methods are different in nature and efficiency. The success of using any of them depends on certain factors; the main factor is the cost of the technology itself. The cost of hedging against risks must not exceed the expected value of the loss that leads to those specific risks. امللخص : تستطيع ال حيث المالية الصعوبات تعاني التي الشركة في المخاطر إدارة كيفية البحث هذا يتناول دفعها يمكنها ال أو المالية بالتزاماتها الوفاء على قادرة غير ألنها الدخل أو اإليرادات تحقيق الشركة فيها. ارتفاع إلى ًا عموم ذلك ويرجع الثابتة النفقات (الرواتب أو العامة النفقات مثل) أو السائلة غير األصول أو االقتصادي للكساد الحساسة اإليرادات. فحسب ً محتمال ًا إفالس الحالة هذه تعاني التي تكاليف ذات الشركات تواجه ال ، تسجيل ًا أيض بل الخطيرة المالية بالصورة اإلدارة تنشغل حيث محاسبية خسارة في الموظفين أداء على ذلك فينعكس وظائفهم بشأن القلق بسبب المتدنية إنتاجية صورة ، والخدمات للسلع المسبق التسديد الموردون ويطلب االئتمان التوسع أو الفواتير تحرير من ً بدال ، تجارية بأعمال للقيام صحة أكثر شركات عن العمالء ويبحث معها. المعنى وبهذا ، تك تؤدي أن يمكن في الدخول إلى الوضعية هذه معالجة عن الناجمة اإلضافية اليف المالية المصاعب درجة يعمق مما مالية دوامة. ف لتقليل استخدامها للشركة يمكن تقنيات أو طرق هناك الكلية مخاطرها ، وكفاءتها طبيعتها في مختلفة الطرق وهذه. عوامل على منها أي استخدام نجاح يعتمد ا العامل معينة؛ القيمة المخاطر ضد التحوط تكلفة تتجاوز أال يجب نفسها التقنية تكلفة هو لرئيسي المحددة المخاطر تلك إلى تؤدي التي للخسارة المتوقعة .
Purpose
This paper aims to provide an overview, a classification of existing research groups for correlated default models using a reduced-form method and an identification of future research opportunities in the field.
Design/methodology/approach
A systematic literature review is used for the identification, selection, evaluation and synthesis of relevant literature using keywords regarding the reduced-form default models in the Web of Science database. The authors also add articles from cross-referencing and expert recommendations to the literature. HistCite ™ program is used to generate a citation map of the literature.
Findings
The results show that reduced-form correlated default risk models are developing towards modelling credit risk with both observable and unobservable variables. The frailty correlated default model at the firm level is still a potential research field.
Originality/value
This is the first paper systematically reviewing the research on reduced-form models of default timing.
This paper provides an overview of the literature that connects capital structure with financial distress costs. These works contain elements from the trade-off theory to the modern financial theory, direct and indirect costs of financial distress, corporate performance, reorganization, and management turnover. Several questions have received a great deal of attention in the literature. First, how should the costs of financial distress be measured? Second, what effects would financial distress have on corporate performance? Third, what is the magnitude of the financial distress costs? Fourth, what are some benefits and costs regarding management changes? This work has analysed and organized the effects of financial distress from the perspective of firms to employees. This literature review aims to create an index for the existing discoveries to guide researchers for their further investigations.KeywordsCosts of financial distressMagnitude of financial distress costsCorporate performanceReorganizationManagement turnover
This research aims to assess the predictive ability of proposed model in a previous research to predict the financial distress of the cargo transport sector in Egypt. To accomplish this, both the future financial position (forecasted by the previous research) and the current financial position in this research was studied, then a comparison had done to determine the degree of congruence or non-congruence between them, and then test the accuracy and ability of proposed model to predict financial distress. The research concluded that despite the previous research forecast that the financial distress improved and reached the safety stage due as the result of support provided by Holding Company for Maritime and Land Transport to modernize the fleet and reduce the debt burden of the companies of this sector, with confirming that the credibility of these results depends on relative stability in the surrounding environment. But current research concluded that a deterioration in the financial position for the same period (predicted) and reached to bankruptcy stage despite continues support from the Holding Company .That's mean there is non-congruence between the current and forecast financial positions, and this non-congruence was not due to weakness of predictive ability of the proposed model, but rather to changing the environment surrounding this sector, the most important which is the increasing in the wage rate which ranged from 122% to 153% of current activity revenues during the research period, In addition to increasing the rest cost of production inputs. After assessing the predictive ability of the proposed model again, the future financial situation of cargo sector in Egypt has been estimated by 2030, which predicts that the sector will reach to bankruptcy stage, and then appropriate recommendations were proposed.
Keywords: Financial distress, Bankruptcy, Predictive models.
Purpose
The purpose of this paper is to examine whether managers of bankrupt firms are more or less conditionally conservative in their financial reporting relative to non-bankrupt firms. The study further examines the cross-sectional differences in conditional conservatism among bankrupt and non-bankrupt firms.
Design/methodology/approach
The study employs a sample of US firms to investigate conditional conservatism in firms that experience financial distress and go bankrupt relative to non-stressed non-bankrupt firms. The study also uses switching regression models to identify the drivers of the cross-sectional difference in conditional conservatism among bankrupt and non-bankrupt firms.
Findings
Empirical results show that bankrupt firms are timelier in recognizing bad news than good news when compared to non-bankrupt firms. The higher level of conditional conservatism in bankrupt firms is mainly driven by their higher levels of leverage and tax-reduction incentives. The cross-sectional analyses show that these results largely hold for more leveraged firms and firms with higher tax costs. Taken together, these results suggest that the conservative tendency of managers of bankrupt firms can stem from the agency problem between lenders and managers and from tax-decreasing motivations.
Originality/value
The novelty of the authors’ research stands in studying the drivers of the cross-sectional differences in conditional conservatism between bankrupt and non-bankrupt firms and specifically, the demonstration that taxation also induces conditional conservatism in the setting of ex post bankrupt firms.
We study the influence of unsecured debt (subordinated debt) on banks’ risk-taking in a contingent claim model where assets are risky debt claims. We consider the bargaining between stockholders and debtholders when choosing the level of asset risk. Replacing part of a bank's stock with subordinated debt leads to risk-shifting events occurring in a narrower domain of asset values (leverage ratios), but can lead to higher levels of risk, depending on the relative bargaining power. When side payments between the bank's claimholders are possible the inclusion of subordinated debt does not affect asset risk. Moreover, we show that severe, yet infrequent, regulatory corrective measures might have adverse effects on risk-shifting.
The risk that a borrower may not fulfil his/her borrowing obligation presents credit owner (lender) a default risk management opportunity to maximize the risk-adjusted rate of return and to maintain minimum exposure to default associated cost. This paper investigated respondents’ perception of the cost of credit default and examines requirements for default risk management (DRM) in the vehicle finance industry in South Africa. It is noted that with an increased level of consumer indebtedness, unstable economy, high unemployment, opportunistic risks like health pandemics, vehicle financing faces a higher probability of default from borrowers. This descriptive investigation utilised quantitative approach using a survey method to collect data from 381 purposive randomly selected respondents who are vehicle finance customers in South Africa, Cape Town specifically. Data collection took place in the Western Cape over a nine-month period, utilising personal interview, and emails to administer questionnaires to vehicle finances’ customers as data collection instruments. Responses received were codified and quantitative data were analysed using the Statistical Packages for Social Sciences (SPSS version 25) The paper found mixed and variable respondents’ perception of the cost of credit default. In conclusion, it is perceived that South Africa debt would become more costly with credit default. It can be recommended that a default risk management intervention be applied to manage credit default risk within the context of the unified credit assessment policy in South Africa.
The bankruptcy system plays an important role in resolving financial distress and reallocating resources in the economy. While many believe that transparency is central to an efficient bankruptcy system, the Bankruptcy Code lacks clear standards for disclosure and financial reporting. In this paper, I study the effects of information disclosure on bankruptcy outcomes by exploiting two sources of plausibly exogenous variation in disclosure during a bankruptcy: the random assignment of bankruptcy judges who may differ in interpreting the disclosure requirements of the law, and a significant change in regulation that increased disclosure by certain creditors but not others. I find evidence that disclosure can both improve asset allocation choices and facilitate more efficient bargaining between creditors. I also highlight two frictions—compliance costs and proprietary costs—that may inhibit transparency and make mandatory disclosure undesirable. My findings provide some of the first evidence on the role of information disclosure in corporate bankruptcy, and I discuss their implications for policy and for the broader corporate disclosure literature.
This study explores determinants of voluntary administration (VA) and deed of company arrangement (DOCA) durations using unconditional quantile regression (UQR). Determinants’ effects are heterogeneous across the VA and DOCA distributions. Determinants related to complexity and negotiation, including size and debt restructuring existence, are positively and negatively related respectively to VA duration, and are stronger at longer durations. Insolvency firm expertise is negatively related to VA duration at shorter durations. Determinants related to scale and procedure, including size and accounting problems, are positively related to DOCA duration, and are stronger at longer durations. No determinants explain short DOCA durations. The UQR results uncovered other new empirical regularities.
The COVID-19 pandemic has no doubt impacted all countries of the world. In its wake, it has left a trail of mortality and an economic crisis of immense proportions. As the virus continues to mutate and containment measures are introduced, the economic challenges posed by the pandemic continue to be felt by households and businesses. By arguing that times of economic crises provide an auspicious occasion for countries to rework their insolvency frameworks and their debt restructuring regimes, this article interrogates the existing debt restructuring regimes in both Kenya and Nigeria, as provided for in the Kenyan Insolvency Act 2015 and the Nigerian Companies and Allied Matters Act 2020, and considers the role of their statutes and institutions created to facilitate debt restructuring. The article further highlights key defects and proposes important and critical changes to these legal frameworks to ensure that they are sufficiently responsive to the pandemic-triggered crisis.
The importance of skilled labor and the inalienability of human capital expose firms to the risk of losing talent at critical times. Using Swedish micro-data, we document that firms lose workers with the highest cognitive and noncognitive skills as they approach bankruptcy. In a quasi-experiment, we confirm that financial distress drives these results: following a negative export shock caused by exogenous currency movements, talent abandons the firm, but only if the exporter is highly leveraged. Consistent with talent dependence being associated with higher labor costs of financial distress, firms that rely more on talent have more conservative capital structures.
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Eurobonds, dubbed as Coronabonds in the context of the current coronavirus crisis, are being hotly debated among the euro area member states amid the COVID-19 pandemic. The debate is in many ways a retread of the euro area sovereign debt crisis of 2011–2012. As China’s “debt centralization/decentralization” experience is comparable with the introduction of Eurobonds in the European Union (EU) in terms of institutional mechanism design, we review our previous series of studies of China’s “debt centralization/decentralization” experience to shed some light on the Eurobonds debate. We obtain three key lessons. First, the introduction of Eurobonds in EU is likely to soften the budget constraint of the governments of the euro area member states. Second, it is also likely to strengthen the moral hazard incentives of the governments of the euro area member states to intentionally overstate their budget problems. Finally, the magnitudes of the moral hazard effects generated by the introduction of Eurobonds in EU are likely larger than their respective counterparts in China.
The Covid-19 pandemic has undeniably ravaged the global economy and plunged many countries in Africa, including Kenya and Nigeria into an economic recession. This article departs from the premise that credit is the lifeblood of market systems. Accordingly, the credit and insolvency laws of both countries must be adjusted in certain ways during and after the pandemic, in order to enable them to cope with the dire economic challenges resulting from the pandemic. The article identifies some material defects in the Insolvency Act 2015 (Kenya) and the Companies and Allied Matters Act 2020 (Nigeria), and argues that these defects will debilitate a meaningful economic recovery from the pandemic. The paper shows the lack of suitability of their existing insolvency frameworks, as well as some aspects of the public law: it proposes a number of tailor-made recommendations that benefitted from the experiences of certain other common law jurisdictions.
This paper shows that short debt maturities commit equityholders to leverage reductions when refinancing expiring debt in low-profitability states. However, shorter maturities lead to higher transaction costs since larger amounts of expiring debt need to be refinanced. We show that this trade-off between higher expected transaction costs against the commitment to reduce leverage in low-profitability states motivates an optimal maturity structure of corporate debt. Since firms with high costs of financial distress and risky cash flows benefit most from committing to leverage reductions, they have a stronger motive to issue short-term debt. Evidence supports the model’s predictions.
Large Italian firms in financial distress are admitted to the business rescue procedure called “Extraordinary Administration” with a view to preserving the business as a going concern when two objective requirements are met: at least two hundred employees and debts not less than two-thirds both of total assets and revenues. This study examines whether these selection criteria are adequate to identify large firms in terms of value creation. The analysis is motivated by the idea that social utility in the rescue of large firms should not be justified only by the number of employees, but also by the worth of the goods and services created by the firms. The sample is made up of 1,581 Italian manufacturing firms and four subsamples were analyzed for the three year period 2015-2017 using a set of logistic regression models. Research findings show that highly leveraged firms eligible to go into “Extraordinary Administration” do not select large firms as measured by proxy variables that take into account value creation, such as total assets and/or revenues. On the other hand, hypothetical alternative selection criteria based on total assets and revenues identify large firms in terms of value creation but no statistical evidence was found to show how these firms are leveraged.
Conventional wisdom in economics recommends that a bankrupt firm with liquidation value greater than going-concern value be liquidated by the creditors and that a firm with going-concern value greater than liquidation value continue to operate. Recently, counterexamples to the traditional rule have been presented. This note argues that violation of the me-first rule is responsible for these counterexamples. Since violation of the me-first rule involves the absence of value-maximization on the part of some economic agents, economic theories concerned with rational behavior may justifiably still assume that the liquidation decision follows the traditional rule.
This article analyzes the economic efficiency properties of bankruptcy liquidation rules, including both conventional legal rules and the me-first rule proposed by economists. It also examines the incentives of firms to undertake investment projects when bankruptcy is a possible outcome. The results show that none of the rules leads to private investment incentives which are socially efficient. Depending on circumstances, it may be privately profitable to liquidate firms which should be continued or to continue firms which should be liquidated. Investments in low productivity projects may be approved while worthwhile projects may be abandoned. Public policy implications are considered.
The report argues that aid volatility is an important source of volatility for the poorest countries. Following a method already applied by the Agence Française de Développement, the report argues that loans to LICs should incorporate a floating grace period, which the country could draw upon when hit by a shock. The definition of a shock should include aid uncertainty, along with others such as commodity shocks and natural disasters. The idea is calibrated to a key IMF policy instrument towards Low-Income Countries, the Poverty-Reducing and Growth Facility (PRGF).
Le rapport montre que l’aide aux pays pauvres contribue à accroître la volatilité de ces pays. Suivant une méthode déjà élaborée par l’Agence Française de Développement, l’article propose d’accorder des crédits aux pays pauvres, qui incorporent un droit de grâce flexible, utilisable par le pays, lorsqu’il est confronté à un choc négatif, quelle qu’en soit la cause : choc d’aide, de prix des matières premières ou catastrophe naturelle. Il montre comment l’instrument utilisé par le FMI à destination des pays pauvres, le PRGF, pourrait être modifié pour ce faire.
This paper integrates elements from the theory of agency, the theory of property rights and the theory of finance to develop a theory of the ownership structure of the firm. We define the concept of agency costs, show its relationship to the ‘separation and control’ issue, investigate the nature of the agency costs generated by the existence of debt and outside equity, demonstrate who bears these costs and why, and investigate the Pareto optimality of their existence. We also provide a new definition of the firm, and show how our analysis of the factors influencing the creation and issuance of debt and equity claims is a special case of the supply side of the completeness of markets problem.The directors of such [joint-stock] companies, however, being the managers rather of other people's money than of their own, it cannot well be expected, that they should watch over it with the same anxious vigilance with which the partners in a private copartnery frequently watch over their own. Like the stewards of a rich man, they are apt to consider attention to small matters as not for their master's honour, and very easily give themselves a dispensation from having it. Negligence and profusion, therefore, must always prevail, more or less, in the management of the affairs of such a company.Adam Smith, The Wealth of Nations, 1776, Cannan Edition(Modern Library, New York, 1937) p. 700.
University Microfilms order no. 9015976. Thesis (D.B.A.)--Harvard University, 1989. Includes bibliographical references.
The purpose of this paper is to understand the institutional features of Chapter 11 from an empirical examination of thirty firms that have emerged from reorganization. We find the recontracting framework of Chapter 11 to be complex, lengthy, and costly. Violations of absolute priority in favor of stockholders are frequently encountered. These deviations may result from the bargaining process of Chapter 11 or from a recontracting process between creditors and stockholders which recognizes the ability of stockholder‐oriented management to preserve firm value. An example of such recontracting addresses Myers' underinvestment problem. An investigation of the effects of Chapter 11 on the pricing of risky debt is also provided.
Claims ultimately awarded to shareholders of firms in reorganization were examined for a sample of thirty filings under the 1978 Bankruptcy Reform Act. The authors measured the amount paid to shareholders in excess of that which they would have received under the absolute priority rule and found that this amount represents, on average, 7.6 percent of the total awarded to all claimants. Evidence is also reported that common share values reflect a significant proportion of value ultimately received in violation of absolute priority, suggesting that deviations from the rule were expected by the equity markets. Copyright 1990 by American Finance Association.
In practice, there are substantial deviations from the doctrine of ‘absolute priority’, which governs the rights of the firm's claimholders in the event of bankruptcy. To determine whether or not the possibility of such deviations is reflected in the prices of the firm's securities, this study examines the risk and return characteristics of financial claims against firms in court-supervised bankruptcy proceedings. Debt claims against bankrupt firms are indeed ‘risky’, exhibiting levels of systematic risk similar to that of common stocks in general. While some of the findings are anomalous, the data are generally consistent with the view that the capital market ‘properly’ prices risky debt claims to reflect both their risk characteristics and the possibility of departures from the doctrine of absolute priority.
BANKRUPTCY COSTS are the deadweight economic costs of firms going bankrupt. They include both ex post bankruptcy costs incurred after a firm's bankruptcy filing, such as transactions costs, and ex ante bankruptcy costs incurred before the filing, such as those resulting from creditors' attempts to reduce their losses if bankruptcy occurs and/or managers' attempts to raise the expected return to equity by increasing the firm's risk.1 This paper has two purposes. First it proposes a model of bankruptcy costs which focuses on the costs of inefficient decision making before the firm's actual bankruptcy filing. The model implies upper bound expressions for total bankruptcy costs. Second, the new U.S. Bankruptcy Code2 went into effect late in 1979 and made important changes in bankruptcy reorganization procedures. The paper poses the question of whether the changes made under the new Code tend to raise or lower aggregate U.S. bankruptcy costs. We approach this question by calculating the upper bound expressions suggested by the model, using parameter values from both before and after the new Code took effect. From an economic standpoint, the most important changes instituted under the new Bankruptcy Code had the effect of making it more difficult to reorganize firms in bankruptcy. Previously, it was common for failing firms to file for bankruptcy, but for prior management to continue to operate the firm in much the same form as before. The bankruptcy filing prevented unpaid creditors from suing the firm while a reorganization plan was arranged which cut back most debts. From an economic standpoint, such a procedure was anomalous, since we learn in basic economics that competition in the long-run should cause inefficient firms to go out of business. As long as failing firms are more likely to be inefficient than firms in general, it would seem to be rewarding inefficiency and offsetting
University of Rochester. The author wishes to thank M. Gruber, R. Hamada, F. Jen, M. Jensen, E. H. Kim, E. Kitch, M. Scholes, J. Siegel, C. Smith, B. Stone, H. Stoll, and J. Williams for their comments on previous drafts. I am indebted to N. Gonedes and especially M. Miller for their encouragement and for their criticisms of previous versions of the paper.
In this paper, empirical evidence with respect to both the direct and indirect costs of bankruptcy is assessed. This should be of interest for three related reasons. First, there is a need to provide further evidence as to the size of bankruptcy costs. Second, for the first time a proxy methodology for measuring indirect costs of bankruptcy is presented and actually measured. Third, a simple format for measuring the present value of expected bankruptcy costs is compared with the present value of expected tax benefits from interest payments on leverage. This comparison has important implications for the continuing debate as to whether or not an optimum capital structure exists for corporations.
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