The costs of bankruptcy

International Review of Financial Analysis 11 (2002) 39 – 57

The costs of bankruptcy A review Ben Branch* Isenberg School of Management, University of Massachusetts, Amherst, MA 01003, USA

Abstract Bankruptcy-related costs may be categorized into four areas: (1) Real costs borne by the distressed firm; (2) Real costs borne directly by the claimants; (3) Losses to the distressed firm that are offset by gains to other entities; (4) Real costs borne by parties other than the distressed firm or its claimants. Cost categories 1, 2, and 3 are relevant for claimants, while Categories 1, 2, and 4 are relevant for society. Focusing on the first three categories, the present study reaches the following conclusions: First, after allowing for their costs of collections, claimsholders recover approximately 56% of the bankrupt firm’s predistress value (PDV). Second, dealing with financial distress generally consumes between 12% and 20% of the distressed firm’s PDV. Taking the midpoint of this range (16%) implies that the losses that lead to the firm’s distress average approximately 28% of its PDV. These estimated values demonstrate the importance of bankruptcy costs in determining an optimal capital structure and explaining the level of risk premiums. Because of its impact on risk premiums, the cost of capital and needed tax rates, the cost of dealing with financial distress has an adverse impact on resource allocations throughout the economy. D 2002 Elsevier Science Inc. All rights reserved. JEL classification: G33 Keywords: Bankruptcy; Liquidation; Reorganization; Chapter 11; Chapter 7

The nature, magnitude, and avoidability of bankruptcy-related costs play a key role in at least three major controversies: reforming the Bankruptcy Code, the existence (or absence) of an optimal capital structure, and the premium on risky debt.

* Tel.: +1-413-545-5690; fax: +1-413-545-3858. E-mail address: [email protected] (B. Branch). 1057-5219/02/$ – see front matter D 2002 Elsevier Science Inc. All rights reserved. PII: S 1 0 5 7 - 5 2 1 9 ( 0 1 ) 0 0 0 6 8 - 0

40

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

1. Introduction Altman (1984) found that the total (direct and indirect) costs of bankruptcy amount to about 15% of predistress firm value for industrial firms and around 7% for retailers. Franks and Torous (1994) concluded that the average incremental cost of a formal proceeding (i.e., bankruptcy) exceeds that of an informal workout by at least 4.5%. Opler and Titman (1994) reported that highly leveraged firms in financial distress tend to lose substantial market share. Finally, in a study of one major case (Federated), Kaplan (1994) found the estimated gains from the bankruptcy-induced financial restructuring process exceeded the cost. Kaplan wonders whether the bankruptcy process typically produces a net gain. Clearly we have a wide range of estimates for financial distress costs. Financial distress costs may be classified into four subcategories: 1. 2. 3. 4.

Real (i.e., not transfer) costs borne directly by the bankrupt firm. Real costs, borne directly by the claimants (but not by the bankrupt firm itself). Losses to the bankrupt firm that are offset by gains to other entities. Real costs borne by parties other than the bankrupt firm and/or its claimants.

Categories 1, 2, and 3 are relevant for determining of bankruptcy costs’ impact on the optimal capital structure, as well as for determining the size and composition of the risk premium. To assess the legal system’s efficiency in dealing with bankruptcy, Cost categories 1, 2, and 4 are relevant. The present analysis focuses upon Cost categories 1, 2, and 3. Cost category 4 is beyond the scope of this review.

2. Estimating the costs of bankruptcy The cost of dealing with financial distress is, in the present analysis, related to the market value of the firm just before it became financially distressed. This methodology follows the practice of most prior studies (e.g., Altman, 1984; Franks & Torous, 1994). It facilitates a useful triaging of the firm’s predistressed value. The predistressed value of the bankrupt firm is equal to the sum of the loss causing the distress (LCD), the firm’s cost of dealing with the distress (CDD), and the gross value recovered by claimsholders (GVR): PDV ¼ LCD þ CDD þ GVR

ð1Þ

where PDV = predistress value, LCD = loss causing distress, CDD = firm’s cost of dealing with distress, GVR = gross value recovered. The gross value recovered by claimsholders (GVR) may itself be divided into the claimsholders’ cost of obtaining that recovery (CRC) and the net value recovered by claimsholders (NVR). GVR ¼ NVR þ CRC

ð2Þ

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

41

In this framework the total bankruptcy-related costs borne by claimsholders in dealing with the bankruptcy (TDC) is the sum of the firm’s (CDD) and the claimsholders’ (CRC) direct costs of dealing with the bankruptcy. Thus: TDC ¼ CDD þ CRC

ð3Þ

Substituting Eqs. (2) and (3) into Eq. (1) yields Eq. (4), PDV ¼ LCD þ TDC þ NVR

ð4Þ

where TDC = total firm and claimsholders’ cost of dealing with bankruptcy (CDD + CRC), NVR = net value recovered by claimsholders’ equal to total value recovered (GVR) less the claimsholders’ cost of obtaining the recovery (CRC). This analysis seeks to estimate the average magnitudes of these components of a bankrupt firm’s PDV. We begin with a benchmark value (PDV) for the firm just before it became distressed. PDV is frequently measured as the total book value of the bankrupt firm’s assets as of its last prebankruptcy financial report. The bankrupt firm will usually report equity value is close to zero (liabilities approximately equal to assets) just before it files. The balance sheet reported just prior to the bankruptcy filing will, however, usually include some overstated asset values and fail to reflect the impact of continuing operating losses. Once the bankruptcy proceeding begins, the true magnitude of these as-yet-unrecognized (on the books) losses will emerge. While the most recent prebankruptcy financial statement may not accurately reflect the firm’s asset value at the time of its report, that statement’s book values may still serve as a useful benchmark of the firm’s PDV. We wish to explore what happens to that value once the firm becomes distressed. How much is the loss that causes the firm to become distressed? How much value is depleted dealing with the distress? And how much is recovered by the claimants? 2.1. Recovery rates An idea of the relative magnitudes of PDV and GVR may be determined from Altman and Kishore’s study (1993) of recoveries on defaulted bonds. They computed the average recovery (defined as the market price immediately after default) for a set of 594 bonds over the 1985–1994 period to be 40.95% of par. The authors update and expand their analysis to 747 bonds for the 1971 – 1997 period finding an averaged recovery rate of 41.66% (unweighted) and 40.32% (weighted by market value) (Altman & Kishore, 1998). In another study, Altman and Eberhart (1994) report recovery rates for firms emerging from Chapter 11 reorganizations. For their sample of 202 defaulted bonds from 91 firms reorganizing over the 1980–1992 period, the average recovery rate amounted to 52.57% of the debt’s par value. When we take account of both the time value of money (Chapter 11’s typically take about 2 years) and the likely lower rate of recovery for those firms that do not reorganize, this somewhat higher percentage of distribution at the reorganization seems consistent with the 41% number. Bank and other types of senior debtholders (who are often protected with collateral) would generally achieve a higher recovery rate than bondholders (which include both senior and

42

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

subordinated issues). Altman and Kishore (1996), for example, find that senior unsecured bondholders recovered about 50% of par in a default situation. Altman and Saxman (1998) report that at year end 1997, their index of defaulted bank loans (covering 18 facilities with a face value of US$3.36 billion) were trading at a market to face ratio of .71 compared to .45 for their public bond index. Similarly, Curty and Lieberman (1996) report a 71% recovery rate on a small (58) sample of senior secured bank loans and 79% on a larger sample (229) of small to medium size bank loans. Asarnow and Edwards (1995) found a 65% recovery for 831 Citibank loan defaults for the 1971–1993 period (the sample involved both secured and nonsecured defaults). Certain other claimsholders (e.g., general creditors, lessors and other holders of rejected contracts), however, may well recover less than the bondholders. Still the average recovery rate for claimsholders is probably between that for bondholders (about 40%) and banks (about 70%). Altman (1993b) reports that the typical bankrupt firm has about US$1.8 of bank debt for every US$1 of bond debt. Applying this ratio to our estimated recovery rates for bank and bond defaults implies a weighted average gross recovery of about 60% for claimsholders. The existing literature may be used to obtain a range of estimates for certain categories of costs.

3. Real bankruptcy costs borne by the firm 3.1. Professional fees Bankrupt firms almost always employ outside professionals. Specifically, lawyers, accountants, investment bankers, appraisers, auctioneers, and actuaries as well as those with experience in selling distressed assets are all likely to be employed in larger bankruptcies. Such professionals generally charge out at substantial (hourly) fees. Similar professionals may well be used in more normal times. Their use, however, is virtually certain to increase when a firm gets into serious financial difficulty. Weiss (1990) studied direct bankruptcy costs for 37 New York and American Stock Exchange bankruptcy filings for the November 1979–December 1986 period. He found direct costs equaled 3.1% of the book value of debt plus the market value of equity (as measured for the fiscal year end immediately prior to the bankruptcy filing). Both Altman (1984) and Warner (1977) derived similar estimates in earlier studies. Warner estimated direct bankruptcy costs to be 4% of market value 1 year prior to bankruptcy for a sample of 11 railroads. Altman estimated the costs to be 4.3% for a sample of 11 retailers and 7 industrial firms. In a more extensive and more recent study Betker (1997) estimated direct costs of 3.93% for 75 traditional Chapter 11 cases and 2.85% for 48 prepackaged Chapter 11’s. Using these sample size numbers as weights, Betker’s composite direct cost estimate is calculated as 3.51%. Thus all four studies came up with a range of about 3.1–4.3% of prebankruptcy market value (Ang, Chua, & McConnell, 1982). In a study of 49 prepackaged bankruptcies, Tashjian (2000) found average direct costs of 1.65% of assets for prevoted plans and 2.31% for postvoted plans. Her results are consistent with those of the other

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

43

authors, as prepackaged bankruptcies are known to be considerably quicker and less costly than other bankruptcy proceedings. Firms also incur distress-related professional fees prior to filing for bankruptcy court protection. They often seek to avoid or at least put off the bankruptcy filing by attempting an informal workout. Gilson, John, and Lang (1990) studied out-of-pocket costs for a sample of 26 successful financial restructurings. They found such exchange offer costs averaged 0.65% of the book value of the distressed firm’s assets. Betker (1997), in contrast, estimates 2.51% for his sample of exchanges. Both of the estimates relate to successful efforts to restructure. To be conservative, the lower value (0.65%) will be used herein. The direct cost of dealing with bankruptcy is largely in the form of fees paid to professionals (especially lawyers and accountants). One might be tempted, therefore, to argue that much of this cost represents wealth transfers (e.g., payments from creditors to bankruptcy professionals). However, the bankruptcy professionals might otherwise have been working on different projects. That foregone activity (e.g., merges or spin-offs) would probably have created something of value. Thus the economic cost of having that individual work on bankruptcy issues is the value that would have otherwise resulted from that foregone activity. Most of those who work in the bankruptcy area are talented individuals. Accordingly, their talents are very likely to be transferable to nonbankruptcy work. Presumably, such individuals produce value in line with their compensation. Thus society foregoes value approximately equal to their compensation when they work on bankruptcy or related projects. In exchange for that forgone value society reaps whatever value is generated by the professionals’ activities. 3.2. Internal staff resources Dealing with bankruptcy almost always requires a significant portion of the Board of Director’s and senior officer’s time and energy. Similarly, substantial amounts of both human and other resources from other departments within the firm are likely to be taken up with the process. For example, the legal, accounting, planning, personnel, and operations staffs all tend to be involved in assessing and dealing with the implications of bankruptcy. The firm must confront the business problems that manifest themselves and/ or result from the bankruptcy. The bankrupt firm may also need to negotiate, but, at a minimum, must communicate with its various categories of interest holders. Their support will be needed to implement the firm’s reorganization plans. The firm must also be able to cooperate with and supply information to its hired outside professionals. All the while, the firm needs to keep its everyday business operations on track under the strained circumstances of bankruptcy. The internal costs of dealing with bankruptcy are rarely reported separately. Indeed, because the tasks are typically only part of each cost center’s total assignment, such costs are especially difficult to assess. Clearly, a bankrupt firm must devote substantial amounts of its own resources to interacting with its hired professionals. The more work done by professionals, the greater the amount of work to be done by the internal staffs who interact with them.

44

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

A crude estimate for these costs may be derived from a couple of case studies. The internal costs reported for liquidating firms that have already disposed of most of their operating subsidiaries are likely to be largely distress-related. The postfailure experiences of two large bank holding companies provide some information on these costs. For the 1991– 1995 period, the Bank of New England Corporation (BNEC) incurred total professional fees (excluding trustee fees) of US$17.7 million and internal administrative expenses (including trustee fees) of US$3.0 million. BNEC is liquidating itself in bankruptcy so all of its internal administrative expenses are associated with dealing with that Chapter 7 liquidation (Branch, 1995). Thus BNEC’s internal costs have amounted to approximately 17% of its professional fees. A second data point is provided by the First Republic Bank (FRB) Chapter 11 case. For 1990 and 1991, by which time all of its operating subsidiaries had been sold, FRB incurred approximately US$10 million in professional fees compared to about US$3.5 million (35% of US$10 million) in internal expenses (Branch & Ray, 1997). These two experiences suggest that the internal costs of dealing with bankruptcy may be in the range of 17–35% of the external costs. Since the external costs appear to average about 4% of the bankrupt firm’s PDV, this 17–35% range implies that internal costs may be in the neighborhood of 0.7% (0.17  0.04 = 0.0068) to 1.4% (0.35  0.04 = 0.014) of the firm’s PDV. These estimates are, however, based on liquidations. Legal and related fees are likely to be relatively large and internal staff costs relatively low for such cases. The staff would have much less to do with ongoing operations that are, in a liquidation, being sold off or shut down, compared with a reorganization where the staff must focus on how to keep the business going long-term. Thus, our 0.7–% range may well be conservative.

4. Real bankruptcy costs borne directly by the firm’s interest holders In addition to the costs borne by the bankrupt firm itself, certain other costs are borne directly by its interest holders. Thus shareholders, bondholders, bankers, trade creditors, federal, state and local revenue departments, landlords, retirees, current employees, and others with interests in the firm (e.g., contract holders and holders of damage claims) are likely to incur additional costs as a result of the firm’s bankruptcy. These costs include: 4.1. Professional fees In a Chapter 11, the bankrupt firm pays for the creditors’ committee’s legal counsel and certain other expenses. The individual interest holders, however, must pay any costs that they incur individually. For example, large institutional interest holders such as banks and insurance companies frequently retain separate legal counsel to assess their legal positions. If the claim or other interest is sufficiently large, and particularly if the issues are sufficiently complex, these representatives may monitor the court proceedings and perhaps the work of the creditor’s committees. If individual proofs of claims need to be filed and monitored, legal assistance is almost always required. Similarly, if the interest is disputed or

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

45

subject to counter claims, the interest holder will need legal assistance. Interest holders may also retain their own accountants, appraisers, investment bankers, etc. to evaluate the debtor’s findings and proposals and perhaps to represent them on the creditors committee. 4.2. Internal staff resources Interest holders must expend their own and their staff’s energy and other resources in assessing and representing their interests (or risk the consequences). A portion of the work may be done by outside professionals, but ultimately, the owner of the interest must be responsible for certain decisions: Should the interest be sold or held? Should a reorganization plan be voted for or against? Should the interest holder take a position at court on various issues such as priority or allowability of certain other claims, payment of professional fees, retention of existing management, or any other matters? Aside from protecting their own claims and voting on a reorganization plan (or acting on an exchange offer), holders of small dollar value interests are likely to let the bankruptcy process take its own course. Large holders, in contrast, may attempt to shape the process in their favor. In some instances the portfolio managers who purchased the interest will be asked to follow their respective distressed positions. In other situations, an in-house specialist will be given the task. Lessors and others having contracts with the bankrupt firm are particularly likely to absorb additional costs and losses as a result of the bankrupt firm’s condition. Holders of such contracts are very often pressured to make concessions. More importantly, many of their contracts are subject to rejection. Rejected contracts holders may assert damage claims resulting from such rejections. The amounts, however, are limited and the claims themselves may well be opposed by the debtor and other claimants. In addition, the holders of rejected contracts may (along with others) be the targets of affirmative fraudulent conveyance and preference claims by the bankrupt estate. Such counterclaims could result in substantial disgorgements from the target. Alternatively, they could be used as negotiating chips to induce the interest holder into compromising his or her claim. Even if the bankrupt estate’s affirmative claim is unsuccessful, legal fees and other costs are likely to be incurred. Clearly, holders of contracts with bankrupt firms are likely to incur significant costs (both professional fees and internal staff resource) to defend their interests. Much of the efforts involved in Items 1 and 2 relate to the pursuit of various claimants’ interests that compete with the interests of other claimants. Claimants may differ in their time horizons and risk orientations. For example, institutional investors may advocate a reorganization plan that seeks to maximize values over a longer time horizon than that preferred by the vulture investors. Similarly, higher priority claimants often advocate a strategy designed to obtain recoveries sufficient to cover most of their claims while offering relatively little to more junior claimants. Junior claimants, in contrast, generally prefer a strategy that in effect risks at least a portion of the more senior claimants’ potential recoveries to obtain an upside potential that if realized would be shared with the juniors. In addition, certain creditors may need to resist attacks on the validity, amount, and priority of their claims. Junior creditors may dispute the priority of the senior’s postpetition interest claim (i.e., Is the junior’s claim subordinated to the senior’s

46

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

postpetition interest claim?). Certain other claims (e.g., those from past managers or creditors who may have forced a bankruptcy filing by withdrawing credit facilities) may be subject to equitable subordination. The amount and validity of severance and other claims of former employees (particularly senior employees associated with the onset of the firm’s financial distress) may face opposition. Finally, management will generally seek to devise and have the creditors accept a plan that preserves their jobs and as much of the enterprise as possible. Many creditors may prefer extensive management changes and asset sales. Trade creditors may be more interested in retaining a good customer than collecting fully on their own prepetition claims. To the extent that one group of interest holders asserts its claims and positions, other groups may need to incur additional costs to maintain their relative positions. Additional resources are required to monitor the managers. Moreover the more resources interest holders focus on monitoring the distressed firm’s management, the more resources the distressed firm may need to focus on dealing with the interest holders. Vulture investors are particularly likely to get involved in not only the monitoring but also the management of distressed firms (Hotchkiss, 2000). Such high levels of involvement are sure to consume resources. Krishnan and Mager’s (1994) study of leasing decisions illustrates the importance of these costs. They find that contrary to leasing theory, leasing is preferred to secured lending where the lessee/borrower has a significant probability of bankruptcy. Thus lessors seek to protect themselves from the cost of dealing with a bankrupt creditor by entering into a lease arrangement rather than a creditor–debtor relationship. One indication of the magnitude of the creditors’ costs of dealing with the distressed debtor comes from Platt’s (1994) study of loan workout costs. He examined a large New England bank’s experience with problem loans. Specifically Platt explored the prebankruptcy ‘‘auxiliary management costs’’ for a large New England bank’s portfolio of defaulted business loans. He identifies four categories of prebankruptcy workout costs: incremental bank labor, external legal fees, appraisal fees, and search fees. Thus Platt’s first category corresponds to our internal staff resources whereas his remaining three categories correspond to our professional fees category. Platt found that these costs averaged 2.4% of the original size of the loan. This estimate may actually understate the costs incurred by the holders of claims against distressed firms. First, by only looking at incremental labor costs, Platt ignored any allocation for overhead or other nonlabor costs. Clearly, workout specialists require office space, equipment, supervisors, etc. Second, his costs only related to the prebankruptcy period for the borrower. Finally, his costs only related to large banks. Banks, particularly large banks, are specialists in loan workout and as such should be able to achieve meaningful scale economies that are unavailable to many other creditors. Still, Platt’s study does illustrate the existence of significant financial distress-related costs borne directly by the creditors. Berger and Young (1997) reach a similar conclusion: ‘‘increases in non-performing loans tend to be followed by decreases in measured cost efficiency, suggesting that high levels of problem loans cause banks to increase spending on monitoring, working out, and/or selling off these loans, and possibly become more diligent in administering the portion of their existing loan portfolio that is currently performing.’’ These costs are conservatively estimated at Platt’s 2.4% value.

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

47

4.3. Reduced marketability As a firm moves from a nondistressed to a distressed state, all of the stakeholders’ interests in it change their characters. The initial holders usually acquired their interests (e.g., bonds, bank debt, trade debt, equity, etc.) at a time when the firm seemed to be financially viable. Now they incur two categories of losses. First, their interests tend to lose value because the distressed firm’s own value declines. Second, the instruments may lose further value to the owner (who may be inclined to sell) because of their reduced marketability. Moreover, the now-distressed instruments are very likely to be less suitable for the original investor than they were when they were nondistressed instruments. Thus, these interest holders now must hold a suboptimal (and costly to monitor and defend) asset or sell it and bear a (potentially much higher) transaction cost that was not expected when the interest was originally acquired. For example, suppliers who meant only to extend short-term credit to facilitate a sale may find that their 30-day receivables have turned into 2-year claims, likely to be paid off at a substantial discount in a bankruptcy proceeding. Few if any trade creditors would have wanted to own such a claim even if they could have purchased it at a very attractive price. Similarly, a typical investment grade or even high yield bondholder is unlikely to wish to hold a defaulted bond. Even banks that are accustomed to holding a portfolio of workout type loans are unlikely to seek them out for investment. Thus claimants and other interest holders of a company that subsequently went bankrupt are very likely to wish to sell their positions. Not only will such sales allow the holders to redeploy their portfolios to a structure more to their liking; these sales may also allow the initial holders to derive the corresponding tax benefit promptly. 4.3.1. Delisting and widening spreads Listed securities are often delisted around the time the firm files for bankruptcy. Securities also become less tradable as their prices fall closer to zero. Even nondistressed securities’ bid–ask spreads and commissions tend to be higher in percentage terms on lower priced issues (Branch, 1977). The additional risks associated with distressed securities may well cause market makers to widen their spreads even further. Nonsecurity claims (e.g., bank and trade debt) are even more of a problem to sell once they become distressed (Case, 1998). The market for nondistressed bank and trade claims is far from perfect. Nonetheless, the promised or expected maturity date generally provides a natural exit. Often, little or no transactions cost will be incurred if that natural exit (i.e., payoff) occurs as promised. Moreover, sales of many such claims are relatively easy to accomplish in the ordinary course of business (e.g., securitization, participation, factoring, etc.). Once the debtor becomes financially distressed, however, the interest becomes much more difficult to sell, even at an appropriately discounted price. Indeed, many similarly positioned interest holders may, more or less simultaneously, seek to sell their recently downgraded interests. Accordingly, the market for such assets may be particularly unbalanced at the very time that the interest holder is most likely to want to sell.

48

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

4.3.2. An example The FoxMeyer bankruptcy provides an example of some of the problems that may be encountered when selling trade claims (Jereski, 1996). The drug distributor FoxMeyer filed for bankruptcy owing about US$500 million in trade claims to such firms as Merck, Eli Lilly, and Glaxo-Wellcome. These claimsholders negotiated sales of about US$80 million of these claims to several investment banking firms including Goldman Sachs, Bear Stern, and Merrill Lynch for about 49¢ on the dollar. These firms in turn expected to sell the claims to investors such as Odyssey Partners who specialize in distressed instruments. Because of the instruments’ nonsecurity nature (i.e., trade credits are not structured for easy trading), the documentation of these proposed transactions was complicated and time consuming. As documenting the transactions was proceeding the market became more aware of the extent of FoxMeyer’s distress, causing the trade claim’s market value to fall to around 20¢. Not surprisingly, the buy side of the incompletely documented transactions at 49¢ sought to disown the trade. The sell side, in contrast, sought to force the transactions through at the original price. 4.3.3. Claims for damages Trading rejected contract and other types of damage claims against a bankrupt party are even more problematic. Clearly, such contingent assets have potential value. Under normal circumstances they can legally be bought and sold. Indeed, investors often participate indirectly in the trading of such claims by purchasing an interest in the claimsholder (e.g., investments in Pennzoil stock while the firm held a disputed claim against a bankrupt Texaco). Direct claims tend to be difficult to trade. The maker is almost always in the best position to pursue the claim and to know its realizable value. Thus, the claims are usually worth more to the maker than to any potential third party buyer. Still, a claim against a nonbankrupt party is on a well-defined time line toward resolution, in or out of court. Once bankruptcy threatens, the claim (or in the case of a rejectable contract, the potential claim) will almost certainly both decline in value and become even less marketable. The anticipated time line toward its resolution is very likely to be extended and made much less predictable by the bankruptcy filing’s automatic stay. In fact, a number of bankruptcy filings have sought to deal with what had become a crushing burden of damage claims (Texaco, Dow-Corning, A.H. Robins, etc.). Distressed interests, particularly low-priced distressed interests, are inherently more costly to trade than otherwise similar investment grade instruments. How large these costs may be will depend upon two principal factors. First, what percentage of distressed instruments are sold prematurely because of the onset of distress? Second, how much do transactions costs increase as a result of financial distress? One suggestive data point on this matter is provided in an article on M.J. Whitman making a market in Kmart receivables (Plitch, 1995). In late 1995, Kmart was viewed as a troubled firm that might eventually file for bankruptcy. M.J. Whitman was making a market in its trade credit, at 80¢ bid 83¢ offered. The bid–ask spread on these claims amounted to almost 4% (0.03/80 = 3.75%). Thus trade creditors who had been expecting to be paid off in full directly by K-Mart were now faced with the possibility of having to incur a substantial transaction cost to liquidate their positions at a discount.

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

49

4.3.4. Trading bank debt More definitive evidence on the impact of financial distress on trading costs comes from a study of traded bank debt spreads by Harwitz and Branch (1998). A sample of 140 loans were divided into four categories: par trading at 98 or above; stressed at 90 to 98; distresses at 65 to 90, and severely distressed below 65. The average bid–ask spreads for these loans are shown in Table 1. Clearly the bid ask spread rises as credit quality declines. We could not explain these results by other factors such as the size of the issue. Accordingly, these findings suggest that transactions costs for bank loans tend to increase with risk. For example, the average spread for a distressed loan is 5.80% compared to 0.61% for a par loan, a difference of 5.16%. The impact is even greater for severely distressed debt where the average spread widens from 0.61% to 7.71% or a difference of 7.10%. How much of the wider spread to assign as a cost to claimsholders depends on the proportion of claimsholders who end up bearing the higher transactions costs. If we conservatively assume that about 50% of the claimsholders will bear these additional costs, and then assign 50% of the increase in the spread to the seller, the net effect will be a distress-related marketability cost of between 1.25% (0.50  0.50  5%) and 1.75% (0.50  0.50  7%). These spreads only apply to bank debt. Houg and Warga (2000), however, find that when bonds are divided into three basic categories — government, investment grade, and below investment grade — average bid–ask spreads increase with risk. Schultz (2001), on the other hand, finds no evidence of increased trading costs for lowerrated bonds. His study, however, only considered trading costs for investment grade bonds. Thus the threshold point at which marketability costs increase appears to be where credit quality falls below investment grade. We see that financial distress imposes two types of costs on its interest holders. The first of these losses, decline in firm value due to distress, is reflected in the costs borne by the firm. The other costs, Items 1, 2, and 3 above, are costs incurred directly by the interest holder. Even though the firm itself does not bear them, at least not directly, it should take these additional distress-related costs into account in its decision process. First, the firm’s managers have a fiduciary duty to manage the firm for the benefit of its owners. In a distress situation, and particularly in a default and/or bankruptcy situation, the creditors begin to take on ownership characteristics. Thus, the distressed firm’s managers should manage the firm largely in their creditors’ interests (Varallo & Finklestein, 1992). Second, the claimants will, or should, take these potential costs into account in their initial pricing decisions. Thus, the firm tends to incur these costs indirectly in the risk premium that it bears.

Table 1 Bid – ask spreads for 140 bank loans Loan quality

Spread (%)

% spread

Par Stressed Distressed Severely distressed

0.61 2.35 5.80 7.71

0.61 2.48 5.90 9.49

50

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

We estimate that the distress-related increased costs of monitoring and managing one’s investments amount to 2.4% of their par value while the higher transactions costs for holders who must sell such issues may add another 1.25% and 1.75%. Thus the total direct costs to the beneficial owners of distressed debt appear to be in the range of 3.65–4.15% (or about 4%) of the claims’ PDVs. Earlier we saw that debt instruments of bankrupt firms typically pay off around 60% of their par value. Thus, the net recovery of these claimsholders (after subtracting the incremental costs borne by the interestholders due to the distress) averages about 56% (60–4%).

5. Losses to the bankrupt firm that may be offset by gains to other entities Many of the costs that a bankrupt firm suffers create opportunities for others. Thus the distressed firm’s loss may be offset, at least in part, by its competitors’ gains. These types of costs include the following. 5.1. Market share loss The disruptions caused by the bankruptcy will generally have an adverse effect on the firm’s ability to compete in the marketplace. Its customers, suppliers, and others will be less inclined to do business with it. Its employees and potential employees will feel less secure working for it. The bankrupt firm is less likely to be able to honor its commitments. This reality makes others less inclined to rely upon its promises. Thus the bankrupt firm’s ability to attract and hold the most suitable employees, customers, and suppliers declines as its condition worsens. The market share lost as a result of one firm’s bankruptcy is a gain for one or more of its competitors. The bankrupt firm will incur losses as a result of its reduced market share and the profits of the share-gaining firms will be enhanced (Chang & McDonald, 1996). These gains and losses will not generally be of equal magnitudes. They will, however, tend be at least somewhat offsetting. Indeed the sales declines are very likely to cause the bankrupt firm’s capacity utilization to fall to less efficient levels. The market share gainers, in contrast, may already be at or near their optimal (at least in the short run) capacities. Thus their share gains may cause these competitors to operate at less efficient above-optimal capacity outputs and/or add capacity while the loser operates at a suboptimal scale and has underutilized capacity. 5.2. Short run focus Bankruptcy will force the firm to shorten its focus. It will need to conserve cash and avoid undertaking most long-term opportunities and fulfilling previous commitments that are not already inescapable. A bankrupt firm simply does not have the luxury of pursuing longerterm opportunities that require cash or otherwise shift attention away from immediately pressing problems. In essence, it will have to apply a very high discount rate to any cashconsuming project. Similarly it will need to accord an equally high implicit return to any

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

51

opportunity to generate cash quickly by foregoing an insufficiently profitable proposal. This short-run high-opportunity-cost-of-capital focus causes many potentially profitable possibilities to be foregone. Such opportunities would have been exploited under more normal circumstances. Similarly, to the extent that a cash-conserving orientation is inefficient, the firm’s true economic costs of operation will rise. For example, deferred maintenance costs are likely to have become greater than they otherwise would have been when those expenses finally can be deferred no longer. Bankrupt firms almost always need, and may well be under creditor pressure, to shed substantial amounts of assets (Shleifer & Vishny, 1992). These assets must generally be sold at bargain prices (Pulvino, 1998). A buyer is thereby able to exploit the seller’s financial distress to acquire useful assets at substantially less than its reservation price. Such a purchaser has gained at the bankrupt firm’s expense. Moreover, the more distressed a firm becomes, the greater its need to sell assets. In addition, many of these assets are illiquid and therefore likely to incur substantial transaction costs (Kim, 1996). 5.2.1. Indirect cost estimates Most of the work on bankruptcy cost has dealt with the direct costs of bankruptcy administration. Most of the rest has been focused on what are generically termed indirect costs. Such costs would include the costs of a short-run focus, as well as costs stemming from a loss in market share. Little or no work, however, has been done to disentangle these two categories of indirect costs. Cutler and Summers (1988) studied the impact on security prices for one very large bankruptcy filing, that of Texaco. Pennzoil alleged that it was damaged by Texaco’s improper interference with its contract to purchase Getty Oil assets. Texaco was forced to file for bankruptcy court protection as a result of a US$13 billion damage award arising out of that dispute. Cutler and Summers found that the combined market values of the two firm’s securities fell by about 30% as a result of the dispute while gaining back only about twothirds of this amount after the settlement. These losses are far greater than any reasonable estimate for direct costs (professional fees, etc.). To quote Cutler and Summers: By creating uncertainty about Texaco’s long-term viability, making it difficult for Texaco to obtain credit, and distracting Texaco’s management, the litigation may have reduced Texaco’s value by more than the expected value of the transfers it would have to make to Pennzoil. Effects of this kind have been stressed in discussions of credit constraints (Greenwald and Stiglitz, 1987) and of the burdens associated with LDC debt obligations (Sachs and Huizinga, 1987). The most important evidence for the adverse effects of the dispute is an affidavit Texaco submitted with its bankruptcy filing that described the effect of the week-old Supreme Court decision on its operations. The affidavit asserted that some suppliers had demanded cash payments before performance or insisted on secured forms of repayment. Others halted crude shipments temporarily or canceled them entirely. A number of banks had also refused to enter into, or placed restrictions on, Texaco’s use of exchange-rate futures contracts. The affidavit concluded: The increasing deterioration of Texaco’s credit and financial condition has made it more and more difficult, with each passing day, for Texaco to continue to finance and operate its business.. . . As normal supply sources become

52

B. Branch / International Review of Financial Analysis 11 (2002) 39–57 inaccessible and other financing is unavailable, Texaco’s operations will begin to grind to a halt. In fact, Texaco already has to consider the prospect of shutting down one of its largest domestic refineries because of its growing inability to acquire crude and feedstock.

This sentiment was echoed by journalistic accounts of Texaco’s actions. The New York Times, for example, noted that ‘‘Texaco has been under extreme financial pressure to resolve the case because of nervousness among its lenders, suppliers, and business partners about its future’’ (December 21, 1985, sec. I, p. 37, col. 5). Some analysts even attributed the stock market reaction to these costs. The Wall Street Journal reported: One analyst says he believes the market is assuming that Texaco will have to pay roughly US$5 billion in cash to Pennzoil. But the market has discounted Texaco’s stock even further because, he says, the company already has been damaged by the litigation ‘‘They’ve been unable to refinance debt they’ve missed opportunities in the oil patch, and the diversion of management has to cost something’’ (April 8, 1987, sec. I, p.3, col. 5).

Unfortunately, no direct evidence exists on whether these operational problems were really of major importance.N Indeed, the day after the affidavit was filed; some of the suppliers mentioned specifically disputed Texaco’s assertions. The principal evidence of their importance is the observation that most reasonable measures of conventional litigation costs are far below the observed fluctuations in joint value (ibid.). N

Attempts to analyze Texaco’s financial statements for evidence on the effects of the litigation were complicated by the large gyrations in oil prices that occurred over the period.

Subtracting the impact of direct costs, Cutler and Summer’s work suggests a stock market price-based estimate of 9% of the indirect costs of distress in the Texaco case. Still, this 9% estimate is only one data point from one high profile case. Moreover, the market had good reason in this case to believe that ending the uncertainty surrounding the dispute (e.g., via a settlement or final court determination) would eventually reverse much of these indirect costs. 5.2.2. Other indirect cost studies In an earlier study, Altman attempted to estimate the indirect costs based on the unexpected loss of profits for the 3 years prior to bankruptcy. His analysis implies indirect costs of 4.5% for retail and 10.5% for industrial firms. Wruck (1990), however, criticized Altman’s methodology: ‘‘because it is impossible to tell whether the loss in profits is in fact caused by financial distress or whether financial distress is caused by the loss in profits.’’ In another study of indirect costs, Opler and Titman (1994) found that firms in the top leverage decile in industries experiencing output contractions suffer a 26% greater loss in sales than do firms in the bottom leverage decile. The market value of their equity declined similarly. While suggesting a significant impact, the Opler and Titman findings do not provide a percentage estimate for the magnitude of the indirect cost of financial distress. Another piece of evidence on indirect costs comes from Chen and Merville (1995). The authors constructed a sample of 1041 firms from the 1992 Compustat tape. They then triaged the sample into firms based on the trend in their Altman Z scores (Altman). Category A consisted of firms that moved from healthy to distressed according to their Z scores while Category C moved in the opposite direction. Category B exhibited no significant trend in Z score. The firms in Category A from healthy to distressed, experienced an average annual market value decline of 8.3% of their total assets subsequent to the time that their Z scores indicated that they had become

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

53

distressed. The authors conclude from this and related findings that the indirect costs of financial distress are significant. They do not, however, generate an estimate for the magnitude of these costs. In yet another study of the issue, Andrade and Kaplan (1998) examine the impact of financial distress on operating income for 31 highly leveraged transactions. These results suggest the indirect financial distress costs may be in the range of 10–17% although they argue that these numbers could be biased upwards. Notwithstanding their problems, taken together the Altman; Cutler and Summers; Opler and Titman; Chen and Merville; and Andrade and Kaplan work suggest that the average indirect costs of bankruptcy are substantial. One might reasonably infer from this literature that such costs, stemming from loss of business and loss of efficiency, are likely to be at least 5% and quite possibly 10% (or more) of the PDV of the distressed firm, in addition to the previously reported estimates of 0.7% to 1.4% for internal staff resources required to deal with financial distress. Note that our earlier discussed estimates for indirect costs include not only the real costs to society but also those costs to the firm that are at least partially offset, from society’s perspective, by gains to others. The existing literature does not provide a basis for estimating how much of the indirect costs represent transfers from one party to another and how much real losses to society.

6. Overall cost estimates The Weiss work suggests that the legal and other professional costs of administering a bankruptcy amount to 3.1% of the book value of debt plus market value of equity. Studies by Warner and Altman suggest a number in the range of 4%. The Gilson et al. (1990) study suggests that prebankruptcy efforts to deal with financial distress may be in the order of 0.65% of assets. My own investigation suggests that the internal staff costs may amount to between 17% and 35% of what the outside professionals charge. This extrapolation would add about 0.7% to 1.4% to the total. The literature on indirect costs points to a very substantial value impact from the short-run focus and loss of market share (Cutler & Summers, 1988). We can probably allocate at least another 5% here and the actual cost could be closer to 10% of the firm’s PDV. In total, this suggests that the firm itself would, on the average, bear the loss in the neighborhood of 9.5% to 16.5% of the firm’s PDV for dealing with the effects of financial distress. Platt’s (1994) work suggests that the claimsholders may incur cost increases of about 2.4% of the claim in monitoring and managing the problems claim. We estimate the impact of reduced marketability at between 1.25% and 1.75% of the claim’s par value. Thus the average cost to claimsholders is in the range of 3.65–4.15%. Accordingly our estimates are shown in Table 2. Holders of interests in a bankrupt firm would, on the average, only recover about 56%, after subtracting costs of about 4% to obtain the recovery, of the value of their claims. They would see an amount equal to 12% to 20% of their claims consumed in the process of dealing

54

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

Table 2 Bankruptcy costs for firms and claimsholders as a percentage of PDV Cost to firm Direct costs Professional fees while in bankruptcy Prebankruptcy costs Internal staff resource costs Total direct costs Indirect costs Total firm costs

3.1 – 4.3% 0.65% 0.7 – 1.4% 4.45 – 6.35% 5 – 10% 9.45 – 16.35%

Cost to claimsholders Monitoring costs Marketability costs Total claimsholders costs Total bankruptcy-related costs to firm and claimsholders

2.4% 1.25 – 1.75% 3.25 – 4.15% 12.70 – 20.50%

with bankruptcy. Thus, an amount equal to about 21% (0.12/0.56 = 0.214) and perhaps as much as 36% (0.20/0.56 = 0.3574) of the amount that the claimsholders recover is on the average lost in dealing with the distressed circumstances. If these costs could be avoided, the average recovery of distressed firm’s claimsholders could increase from about 56% of their claims to a range of 68–76% of their claims.

7. Conclusion Notwithstanding its limitations, this analysis reaches some important conclusions: First, the bankruptcy process imposes costs on a very wide array of parties including the owners and direct creditors of the troubled firm and many other parties. For example, those having contacts with (landlords, suppliers, customers, employees, etc.) or potential claims against (e.g., product liability claims) need to be considered when the magnitudes of bankruptcy costs are assessed. The current analysis only begins to explore the magnitude of these costs. Second, those having direct claims against the bankrupt firms (e.g., creditors and other claimants) will not only incur losses due to the decline in the value of their interest but also incur direct individual-specific costs associated with the changed characteristic of that interest. In particular, an interest in a bankrupt entity is likely to require considerably greater attention and costs to manage and be considerably more difficult and costly to sell than was the case when the issuer was not distressed. Third, the current analysis suggests that, on the average, the par value of the distressed firm’s prebankruptcy debt is allocated as follows: 1. The loss, which caused the bankruptcy, consumes about 28%; 2. The cost of dealing with distress consumes about 16%; 3. The net value available to distribute to the claimsholder amounts to about 56%.

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

55

Fourth, since a significant part of the value of the bankrupt firm is consumed in dealing with its distress, bankruptcy costs play an important role in determining the optimal capital structure. The costs of dealing with bankrupt securities (particularly those costs that are borne directly by the interest holder) help explain the magnitude of the risk premium. Indeed, what has been termed the pure risk premium (gross risk premium less the anticipated default loss) may be largely explained by the extra management costs that must be incurred by those who hold interests in bankrupt parties. The cost of dealing with bankruptcy has an adverse impact on the risk premium, cost of capital and needed tax rates and therefore the allocation of resources. References Altman, E. (1993, May – June). A further empirical investigation of the bankruptcy cost question. Journal of Finance, 1067 – 1089. Altman, E. (2000). Defaulted bonds: demand, supply and performance, 1987 – 1992. Financial Analysts Journal, 55 – 60. Altman, E. (1977, March). Corporate financial distress and bankruptcy (2nd ed., p. 118). New York: Wiley. Altman, E., & Eberhart, A. (1994). Do seniority provisions protect bondholders’ investments? Journal of Portfolio Management, 67 – 75. Altman, E., & Kishore, V. (2000, February). Almost everything you wanted to know about recoveries and defaulted bonds. Financial Analysts Journal, 57 – 64. Altman, E., & Kishore, V. (1998). Default and returns on high yield bonds: analysis theory 1997. NYU Working Paper Series S-98-1. Altman, E., & Saxman, M. (1998). The investment performance of defaulted bonds and bank loans: 1987 – 1997 and market out look. New York University Solomon Center Working Paper S.-98-2. Altman, E., & Suggitt. (2000). Default rates in the syndicated bank loan market: a mortality analysis. Journal of Banking and Finance, 24, 229 – 253. Andrade, G., & Kaplan, S. (1998). How costly is financial (not economic) distress? Evidence for highly leveraged transactions that become distressed. Journal of Finance, 1443 – 1493. Ang, S., Chua, J., & McConnell, J. (1989). The administrative costs of corporate bankruptcy: a note. Journal of Finance, 219 – 225. Asarnow, E., & Edwards, D. (1993, Autumn). Measuring loss on defaulted bank loans: a 24 year study. Journal of Commercial Bank Lending, 11 – 19. Berger, A., & Young, R. (1997). Problem loans and cost efficiency in commercial banking. Journal of Banking and Finance, 21, 849 – 870. Betker, B. (1997, Winter). The administrative costs of debt restructurings: some recent evidence. Financial Management, 56 – 68. Branch, B. (1987). The determinants of bid – asked spreads on the OTC market. Industrial Organization Review, 4 (2), 679 – 674. Branch, B. (1995). Third report of Dr. Ben Branch, Chapter 7 trustee to the United States Trustee for the period through March 31, 1995. Case No. 91-10126 (WCH) (Chapter 7), in the United States Bankruptcy Court for the District of Massachusetts Eastern Division. Branch, B., & Freed, W. (1977, March). Bid – asked spreads on the AMEX and the big board. Journal of Finance, 32(1), 159 – 163. Branch, B., & Ray, H. (1997, November). First republic and FDIC: a case study. International Review of Financial Analysis, 193 – 208. Brown, D., James, C., & Mooradian, R. (1994). Asset sales by financially distressed firms. Journal of Corporate Finance, 233 – 257.

56

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

Brown, T. (2000, February). Liquidity and liquidations: evidence from real estate investment trusts. Journal of Finance, 55 (1), 469 – 485. Case, S. (1998). Trading in claims. In: W. Norton (Ed.), Annual survey of bankruptcy law, 1998 – 1999 ( pp. 45 – 66). West Group Deerfield, IL. Chang, T., & McDonald, J. (1996, November). Industry structure and ripple effect of bankruptcy announcements. Financial Review, 783 – 807. Chen, G., & Merville, L. The indirect costs of bankruptcy: a probability analysis. Unpublished paper presented to the 1995 Financial Management Association meetings. Clark, G. (1991). Regulating the restructuring of the U.S. steel industry; Chapter 11 of the Bankruptcy Code and pension obligations. Regional Studies, 25 (2), 135 – 153. Clark, G. L. (1991, April). Regulating the restructuring of the US steel industry: Chapter 11 of the Bankruptcy Code and obligations. Regional Studies, 135 – 153. Connor, J. (2001, May). Finding value in distressed properties: a case study. Journal of Corporate Renewal, 14 (5), 16 – 18. Carty, L., & Lieberman, S. (1996, November). Defaulted bank loan recovery. Moody’s Investor Service, 1 – 13. Cutler, D., & Summers, H. (1988). The costs of conflict resolution and financial distress: evidence from the Texaco – Pennzoil litigation. Rand Journal of Economics, 19 (2), 151 – 172. Engleman, K., & Cornell, B. (1998). Measuring the costs of corporation litigation: 5 case studies. Journal of Legal Studies, 25 (2), 377 – 399. Franks, J., & Torous, W. (1994). A comparison of financial restructuring is distress exchanges and Chapter 11 reorganizations. Journal of Financial Economics, 349 – 370. Gilson, K., John, K. & Lang, L. (1990). Troubled debt restructuring: an empirical study of private reorganizations of firms in default. Journal of Financial Economics, 27, 315 – 353. Gilson, S. C. (1989). Management turnover and financial distress. Journal of Financial Economics, 25, 241 – 262. Harwitz, S., & Branch, B. (1998). A study of the reported percentage spreads for depressed bank loans. Unpublished working paper, University of Massachusetts. Hotchkiss, E. (2000, August). Defaulted debt and the market for control. Journal of Corporate Renewal, 13 (8), 4 – 9. Houg, G., & Warga, A. (2000, March/April). An empirical study of bond market transactions. Financial Analyst Journal, 32 – 46. Jereski, L. (1996, September 18). FoxMeyer bankruptcy filing gets messy. Wall Street Journal, 1 – 2. Jog, U. M., Kotlar, I. D., & Tate, G. (1993, Autumn). Stockholders losses in corporate restructuring: the evident fees from losses in the North American steel industry. Financial Management, 185 – 201. Kaplan, S. (1994). Campeau’s acquisition of federated post-bankruptcy results. Journal of Financial Economics, 35, 123 – 136 (North Holland). Kim, C. (1996, September). Asset liquidity and the indirect costs of financial distress: evidence from the contract drilling industry. Unpublished working paper (University of Chicago) presented to First New England Doctoral Student Symposium, University of Massachusetts. Krishnan, V., & Mager, R. (1994, Summer). Bankruptcy costs and the financial leasing decision. Financial Management, 31 – 42. LoPucki, L. M. (1983). The debtor in full control; Systems failure under Chapter 11 of the bankruptcy code? American Bankruptcy Law Journal, 57, 99 – 126, 267 – 273. Opler, T., & Titman, S. (1994, July). Financial distress and corporate performance. Journal of Finance, 1015 – 1040. Platt, H. (1994, Winter). Measuring the cost of loss workout. Journal of Retail Banking, XI (4), 39 – 44. Plitch, P. (1995, December 6). Whitman put contract seeks to lessen risk if Kmart files huge Chapter 7. Wall Street Journal, 3. Pulvino, T. (1996). Effect of bankruptcy court protection on asset sales. Unpublished working paper, Northwestern University. Pulvino, T. (1998, June). Do asset fire sales exist? An empirical investigation of aircraft transactions. Journal of Finance, 939 – 978.

B. Branch / International Review of Financial Analysis 11 (2002) 39–57

57

Schultz, P. (2001, April). Corporate bond trading costs: a peak behind the curtain. Journal of Finance, 56 (2), 644 – 698. Shleifer, A., & Vishny, R. (1992, September). Liquidation value, and debt capacity: a market equilibrium approach. Journal of Finance, 1343 – 1366. Sutton, R., & Callahan, A. (1987). The stigma of bankruptcy: spoiled organizational image and its management. Academy of Management Journal, 30, 405 – 436. Tashjian, E. (2000, March). Outcomes in prepackaged bankruptcies. Journal of Corporate Renewal, 13 (13), 4 – 9. Varallo, V., & Finklestein, J. (1992, November). Fiduciary obligations of directors of the financially troubled company. Business Lawyer, 48, 239 – 255. Waldman, R., & Altman, E. (1999, july 8). High yield defaults. Solomon Smith, 1 – 13. Warner, S. (1977, May). Bankruptcy costs: some evidence. Journal of Finance, 2, 337 – 347. Weiss, L. (1990, March). Bankruptcy resolution: direct costs and violation of priority claims. Journal of Financial Economics, 285 – 314. Wruck, K. (1990). Financial distress, reorganization and organizational efficiency. Journal of Financial Economics, 27, 438.

Further Reading Altman, E. (1984, September). Defaulted bonds: demand, supply and performance, 1987 – 1992. Financial Analysts Journal,, 55 – 60. Altman, E., & Suggitt, E. (1993a, May – June). Default rates in the syndicated bank loan market: a mortality analysis. Journal of Banking and Finance, 24, 229 – 253. Branch, B., & Freed, W. (1993b). Bid – asked spreads on the AMEX and the big board. Journal of Finance, 32 (1), 159 – 163. Brown, D., James, C., & Mooradian, R. (1994, Summer). Asset sales by financially distressed firms. Journal of Corporate Finance,, 233 – 257. Brown, T. (1996, November/December). Liquidity and liquidations: evidence from real estate investment trusts. Journal of Finance, 55 (1), 469 – 485. Clark, G. (2001). Regulating the restructuring of the U.S. steel industry; Chapter 11 of the Bankruptcy Code and pension obligations. Regional Studies, 25 (2), 135 – 153. Clark, G.L. (1991, April). Regulating the restructuring of the US steel industry: Chapter 11 of the Bankruptcy Code and obligations. Regional Studies,, 135 – 153. Connor, J. (2001, May). Finding value in distressed properties: a case study. Journal of Corporate Renewal, 14 (5), 16 – 18. Engleman, K., & Cornell, B. (1998, October). Measuring the costs of corporation litigation: 5 case studies. Journal of Legal Studies, 25 (2), 377 – 399. Gilson, S.C. (1982, March). Management turnover and financial distress. Journal of Financial Economics, 25, 241 – 262. Jog, U.M., Kotlar, I.D., & Tate, G. (1995). Stockholders losses in corporate restructuring: the evident fees from losses in the North American steel industry. Financial Management,, 185 – 201. LoPucki, L. M. (1983). The debtor in full control; Systems failure under Chapter 11 of the bankruptcy code? American Bankruptcy Law Journal, 57, 99 – 126, 267 – 273. Pulvino, T. (1996). Effect of bankruptcy court protection on asset sales. Unpublished working paper, Northwestern University. Sutton, R., & Callahan, A. (1977). The stigma of bankruptcy: spoiled organizational image and its management. Academy of Management Journal, 30, 405 – 436. Waldman, R., & Altman, E. (1999, july 8). High yield defaults. Solomon Smith, 1 – 13.