Bank Responses to Corporate Reorganization: Evidence from an Emerging Economy.
| Autor | Oreng, Mariana |
Introduction
According to Jackson (1982), most of the bankruptcy process concerns creditor distribution questions rather than discharge of the debtor. Along these lines, reaching a common agreement between creditors and debtors is crucial to reorganization filings. Because banks and secured institutional lenders are those creditors who are typically able to influence corporate policies (Bae & Goyal, 2009; James, 1995), our goal is to assess the role of financial creditors during corporate reorganizations. While some studies have focused on the conflict between debtors and representative creditors (Bebchuck, 2002) and the resolution of disputes between creditors (Gilson, Hotchkiss, & Ruback, 2000), this paper investigates how banks (as both secured and unsecured creditors) vote on the reorganization plans of firms that exhibit a higher degree of information asymmetry than large and public companies. To our knowledge, there is a shortage of explanations for the behavior of senior and junior banks during corporate reorganization processes of medium and small companies. Therefore, the question under investigation is how do bank creditors with different seniorities vote on corporate reorganization filings of small and medium companies? Our secondary question is related to the association between creditor conflict and reorganization outcomes.
This study adds to the bankruptcy literature by offering important insights into the creditors' bargain model and by analyzing a unique dataset that was not previously available and that contains bankruptcy court documents from 125 corporate reorganization filings in Brazil from 2006 to 2016. First, we shed light on the association between bank creditors' decisions and the reorganization outcomes of smaller and medium companies (SMEs) that exhibit a higher level of information asymmetry. This analysis is relevant in the context of emerging economies, where SMEs' financial statements often exhibit a higher level of opacity and where companies rely more on bank debt than on capital market instruments. While evidence of reorganization issues for public companies with a diverse pool of creditors (Franks & Sussman, 2005) abounds for both emerging (Claessens, Djankov, & Klapper, 2003) and developed economies (Brunner & Kahnen, 2008; Westbrook, 2015), deeper analysis for SMEs in creditor-oriented bankruptcy regimes is still in progress (Franken, 2004). Our study is an opportunity to fill this gap. Second, while most studies begin by assuming that senior creditors exert strong control over the reorganization process (Ayotte & Morrison, 2009; Branch & Ray, 2007), we take a step back to understand which factors are associated with conflicting decisions by banks with different seniorities and by analyzing the decisions from the point of view of real options (Baird & Morisson, 2001).
Following the trend in the finance literature, this study is a hybrid between law and financial distress issues. We focused on the descriptive statistics of the data collected and performed parametric and nonparametric average tests to understand the role of the conflict between bank creditors in the final outcome of reorganizations. We also use logit and probit specifications to understand which factors are associated with creditors voting in favor of a reorganization.
Collectively, our analysis demonstrates that conflict between bank creditor classes is positively associated with the proportion of senior bank debt and the proportion of labor debt. Contract terms also seem to be highly correlated with disagreements between bank creditors: in cases of conflict, the debt of senior bank creditors received higher interest rates, and these creditors had to wait 3 times longer before receiving any payment. In this sense, our results corroborate the idea that senior creditors have come to dominate the reorganization process. Logit and probit specifications provide evidence of a coordination problem between creditors, in accordance with the literature: we find a concave relationship between favorable votes and the number of bank creditors involved in a reorganization and between favorable votes and a company's age. This indicates that when considering the number of banks involved, the likelihood of a bank voting in favor of a reorganization rises at decreasing rates. Moreover, although banks will favor the reorganization of older companies, this isn't necessarily true for the ones that have existed for too long and thus might not be able to reorganize in a proper manner due to bad management or lack of technologies, for instance, where creditors would be better off when they are liquidated.
This research is timely for a variety of reasons. First, recent bankruptcy studies have shifted the focus away from equity and managerial control to creditor behavior. These studies demonstrate that senior lenders use several strategies to limit the bargaining position of subordinated debt holders during reorganizations (Ayotte & Morrison, 2009; Branch & Ray, 2007), which reinforces the need to study the conflicts between creditor classes. Second, the number of corporate reorganization filings in Brazil increased from 252 to 828 between 2006 and 2014, which amounts to an increase of approximately 14% per year. In 2015, due to Brazil's economic crisis, this number has jumped to 1287, which represents an increase of 55% in only one year. The peak of requests occurred in 2016, as companies still faced two main negative impacts of the Brazilian economic recession: the lower inflow of cash and increasingly expensive debt, making it difficult to finance and renegotiate debts (Copetti, 2017). Although some practitioners argue that some of these filings are only precautionary measures, the increase was significant. Figure 1 demonstrates that the Brazilian services sector suffered the most, with the highest increase in reorganization filings, followed by retail.
The paper proceeds as follows: the next section reviews the previous literature. Data analysis and the role of conflict between bank creditor classes is presented in the third session. The fourth session covers our cluster analysis and logistic regression results. The conclusion and references follow.
Prior Literature
Many authors argue that reorganization is a two-stage game (Bulow & Shoven, 1978; Fama, 1985; Fisher & Martel, 1995; White, 1981). In the first stage, firms decide whether to file for reorganization. Once a reorganization procedure is chosen over liquidation, "there is a conflict between the secured creditors' right to claim their collateral versus the goal of reorganizing the firm" (Araujo & Funchal, 2005, p. 4). In the second stage, creditors bargain and vote in favor or against the reorganization.
We identified several approaches in the literature to modeling creditor responses to corporate reorganizations. Some studies view the bargaining between creditors as a noncooperative game (Annabi, Breton, & Francais, 2012), while others argue that this process can be depicted as a collective action problem or as a larger-scale prisoner's dilemma (Fan & Sundaresan, 2000; Jackson, 1982; Li & Li, 1999). Another study addresses the bankruptcy decision as the exercise of a real option, as claimholders have incentives to withhold information due to the process length (Baird & Morisson, 2001). The conflict of interest lies in the fact that when a company files for bankruptcy, its market value is lower than the total amount of its debt. Hence, the creditors know that their best interest will be maximized as long as they cooperate. Moreover, covering all aspects of negotiations, such as the future use of the firm's assets or how much and what type of securities the various creditors will receive, can result in a lengthy and costly procedure (Hotchkiss, John, Mooradian, & Thorburn 2008).
Even though bankruptcy law is designed to avoid coordination problems and contract incompleteness, Jackson (1982) argues that "bankruptcy law's beguiling slogan has been little more than a banal reminder that equals are to be treated equally in bankruptcy: the important determination of who those equals are is often not resolved under bankruptcy law" (p. 860). According to the author, "a more profitable line of pursuit might be to view bankruptcy as a system designed to mirror the agreement one would expect the creditors to form among themselves were they able to negotiate such an agreement from an ex ante position" (p. 860). Thus, in his view, bankruptcy proceedings are at the back end of the creditors' bargain model. In fact, several studies have demonstrated that deviations from the absolute priority rule occur in practice (Eberhart, Moore, & Roenfeldt, 1990; Franks & Torous, 1989; Weiss, 1990). In Germany, a financial institution is appointed to mitigate the risk of uncoordinated creditor action (Bankenpool). However, we find no documentation of such an instrument in Brazil or the United States. In this sense, bank creditors' bargaining is a coordination problem (Brunner & Kahnen, 2008).
Branch and Ray (2007) argue that subordinate debtholders have considerable leverage in the bankruptcy negotiation process due to courts' bias toward obtaining consensual plans and their ability to block or delay confirmation of a plan that provides subordinate debtholders with little or no recovery. Secured debtholders, on the other hand, can obtain a recovery in liquidation, which provides nothing for junior creditors. Even though bankruptcy laws are written in such a way that the Absolute Priority Rule should not be violated, senior creditors can use several strategies to limit the bargaining position of junior creditors, such as vote dilution, the enforcement of indenture provisions or by exercising control through stringent covenants. This bargaining between secured and unsecured creditors can distort the reorganization process. Ayotte and Morrison (2009) argue that creditors with senior...
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