Postbankruptcy

Performance and
Management Turnover

Edith Shwalb Hotchkiss

Presented by Ankur Saxena
 Introduction
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 the process 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 management’s role in the chapter 11 process may be an important
source of bias. There are other factors outside of management’s control that affect
subsequent performance.
 Trends in Management
During Bankruptcy
 Over Half of the Sample Firms in the analysis have replaced their CEO’s 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 is
implemented 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.
 Theoretical 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 distress show
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 to increased
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.
 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 poor investment decisions made in
bankruptcy are reflected in the postbankruptcy performances of firms emerging from the
process.
 Trends of Companies who
filed chapter 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.
 Success 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.
Success after 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 but profitability 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.
 Conclusions

 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 the
current 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 office through the time the
projections were made.