Chapter 11 Bankruptcy

Chapter 11 Bankruptcy

Chapter 11 Bankruptcy

INTRODUCTION3

2. Bank-bidder coalition overbidding5

2.15

2.2. The coalition's optimal bid5

2.3. Incentive compatibility and bid delegation8

2.4. The bank as monopolist seller10

2.5. Factors attenuating overbidding10

2.6. A testable restriction on overbidding11

3. Data and sample characteristics13

3.1. The auction setting13

3.2. Characteristics of auctioned firms14

3.3. Bid activity and auction premiums16

4. Does coalition overbidding exist?19

4.1. Testing the overbidding theory19

4.2. Robustness tests22

4.3. Agency and overbidding through bank-debt rollover29

5. Overbidding and post-bankruptcy performance30

5.1. Post-bankruptcy operating performance31

5.2. Bankruptcy refiling rates33

Conclusions35

Introduction

A firm filing for bankruptcy is turned over to a court-appointed trustee who puts the firm up for sale in an auction. This mandatory auction system has an attractive simplicity. All debt claims are stayed during the auction period and the bids determine whether the firm will be continued as a going concern or liquidated piecemeal. Payment must be in cash, allowing the auction proceeds to be distributed to creditors strictly according to absolute priority. Moreover, the auctions are quick (lasting an average of 2 months) and relatively cost-efficient, and as much as three-quarters of the filing firms survive the auction as a going concern (Thorburn, 2000). A going-concern sale takes place by merging the assets and operations of the auctioned firm into the bidder firm, or into an empty corporate shell—much like a leveraged buyout transaction.

There is an ongoing debate over the relative efficiency of auction bankruptcy versus Chapter 11 in the U.S., where firms are reorganized in bankruptcy. Proponents of a more market-oriented auction system point to costs associated with conflicts of interests and excessive continuation of operations due to managerial control over the restructuring process in Chapter 11.1 Perhaps as a result, there is a trend towards increased use of market-based mechanisms in the U.S., as evidenced by prepackaged bankruptcies ([Betker, 1995] and [Lease et al., 1996]), participation by distressed investors (Hotchkiss and Mooradian, 1997), and sales in Chapter 11 ([Hotchkiss and Mooradian, 1998] and [Maksimovic and Phillips, 1998]). In fact, Baird and Rasmussen (2003) report that more than three-quarters of all large Chapter 11 cases resolved in 2002 involved the sale of company assets or a prepackaged bankruptcy procedure.

On the other hand, proponents of Chapter 11 argue that the time pressure of an auction system is costly as it possibly causes excessive liquidation of economically viable firms when potential bidders in the auction are themselves financially constrained. However, Eckbo and Thorburn (in press) fail to find auction fire-sale discounts in going-concern sales, and the three-quarters survival rate reported for the Swedish auction system is similar to that of Chapter 11. Also, in Eckbo and Thorburn (2003) we show that firms purchased as going concerns in the auction tend to perform at par with non-bankrupt industry rivals.

Thesis Statement

Research suggests that the role of empty creditors in chapter 11 bankruptcy proceedings is primarily disadvantageous to both regular creditors and debtors due to the fact that empty creditors are acting to protect their economic interest by forcing companies in bankruptcy to liquidate thus damaging the rights of other stakeholders in the ...