Firm Performance and the Strategic Components of Bankruptcy Reorganization Plans.
| Autor | Monteiro, Guilherme Fowler A. |
Introduction
When a company faces failure in business, it usually follows one of two paths. The firm may seek an out-of-court agreement with its creditors, or it may go bankrupt. In the latter case, the firm may file for a liquidation bankruptcy, meaning that it ceases its operations and agrees to dispose of its assets so that the creditors receive at least a portion of the amount they are owed. Alternatively, the company may file for a reorganization bankruptcy. In this case, creditors' claims are postponed while the company undertakes actions with the deliberate intention to restructure its operations.
The basic assumption of reorganization bankruptcy is the ability of a distressed firm to "convince creditors it can succeed in the marketplace by implementing a new strategic plan and that when the plan produces profits, the company will be able to repay its creditors" (Pearce & DiLullo, 1998, p. 67). Therefore, one of the most important elements of reorganization bankruptcy is reorganization plans. If a plan is consistent, there are chances for the company to restructure itself and overcome the crisis. If a plan is inconsistent, represents only pages devoid of meaning, and has the sole purpose of meeting legal prerequisites, then the recovery of the company can never occur.
Given the role of reorganization plans in the recovery of distressed firms, we perform an exploratory analysis of the strategic components of the plans. Our main objective is to identify the most prominent strategic elements of bankruptcy reorganization plans and how they connect to firm performance. To accomplish this task, we perform an in-depth investigation of a set of plans, linking its strategic components to the performance of firms under reorganization bankruptcy by means of a qualitative comparative analysis (QCA).
We develop our study in Brazil. The country has a history of crises, which makes it an interesting case to analyze the issue. For example, Brazil is famously known for economic volatility in a context of high inflation rates in the 1980s and 1990s. More recently, a combination of political and economic issues plunged the country into a severe crisis in the aftermath of the global meltdown of 2008. Bellini, Palvia, Moreno, Jacks and Graeml (2019) assert that the country's recent crisis can be divided into two moments. The first, called the pre-awareness moment, occurred in the first half of 2015. During this period, citizens did not have a clear understanding of the depth and breadth of the crisis. The second moment, in the first half of 2016, was characterized by the government's admission about the seriousness of the crisis, which was already strongly affecting the lives of people and businesses. From June 2005 (when the bankruptcy law in force was passed in Brazil) until September 2019, there were 60,543 reorganization bankruptcy requests granted by the courts in the country. Of this total, 54% of requests were made by micro and small companies, 29% by medium businesses and 17% by large companies (Serasa Experian, 2019).
In this paper, we develop our argument in two steps. First, we examine the theoretical aspects of reorganization bankruptcy and outline a simple model of the strategic components of a reorganization plan. Second, we present our empirical analysis, describing the sample, the variables and the fuzzy-set QCA methodology. Based on our analysis, we find that managers involved in corporate reorganization processes must pay particular attention to four elements: (a) the diagnosis of the factors causing the crisis, (b) the resources owned by the firm, (c) the industry analysis, and (d) the identification of the firm's competitive strengths. Specifically, our results suggest that the absence of an industry analysis is associated with a decline in the financial situation of the firm, which is in line with the traditional predictions of the strategy literature (McGahan & Porter, 1997; Porter, 1985). However, the explicit mentioning of the firm's relevant market is negatively associated with the company's uplifting in crisis.
The results above make two important contributions to the literature. First, we expand the debate on business turnaround and reorganization bankruptcy by shedding light on an antecedent that has not yet received much attention, namely the bankruptcy reorganization plan. In doing so, we deepen knowledge about the determinants of successful turnarounds ( Boyne & Meier, 2009; D. D. Baker & Cullen, 1993; Schweizer & Nienhaus, 2017; V. L. Baker & Duhaime, 1997). Specifically, we bring insights into the turnaround strategies used by companies (Schweizer & Nienhaus, 2017) and the decision process and practice in times of organizational failure (Serra, Pinto, Guerrazzi, & Ferreira, 2017). Second, by mapping the strategic components of reorganization plans, we develop a holistic view of the strategic building process. This contributes to the debate on the theoretical integration of the different strategic elements (Hooley & Greenley, 2005; Madhok, 2002; Mahoney & Pandian, 1992; Nickerson, Hamilton, & Wada, 2001; Sheehan & Foss, 2017).
Background
Reorganization bankruptcy and reorganization plans
When a company goes into reorganization bankruptcy, its leaders generally formulate a turnaround strategy hoping to convince investors and creditors that the return to profitability is achievable. The usual turnaround process is designed to reverse the negative situation of the company and make it return to or exceed pre-crisis performance levels (Hofer, 1980; Lim, Celly, Morse, & Rowe, 2013; O'Neill, 1986; Trahms, Ndofor, & Sirmon, 2013).
Specifically examining the turnaround process, Pearce and Robbins (1993) divide it into two stages: turnaround situation and turnaround response1. The turnaround situation stage occurs when a firm faces multiple periods of decline in its financial performance after a relatively long, stable period of prosperity. Turnaround situations are caused by a combination of external and internal factors that may generate circumstances with different degrees of severity, ranging from a reduction in margins and sales to bankruptcy. The turnaround response stage, in turn, can usually be divided into two phases: retrenchment and recovery2. The primary objective of the retrenchment phase is to produce the financial stabilization of the company. To this end, managers seek to raise the firm's efficiency by reducing costs and assets relative to the earnings generated. The intent of retrenchment is to enable the recovery of the firm through maintenance of efficiency and/or the entrepreneurial reconfiguration of the firm (Pearce & Robbins, 1993).
Considering these two stages of the turnaround process, Pearce and DiLullo (1998) argue in favor of a strategic plan that openly incorporates the possibility of firm bankruptcy (see also Flynn & Farid, 1991; Moulton & Thomas, 1993). According to Pearce and DiLullo (1998), the possibility of bankruptcy can be explicitly incorporated into the strategic planning of a firm when one contemplates the turnaround situation as a potential bankruptcy situation. Based on this argument, our basic claim in this paper is that the inclusion of a strategic planning exercise into the turnaround stage sheds light on another stage so far disregarded in the majority of turnaround discussions: the stage of reorganization plan formulation. In line with most statutory schemes, the plan must be accepted by the majority of creditors, and the plan's feasibility must be confirmed by the bankruptcy court. Thus, the reorganization plan is a key element of the turnaround process when it involves bankruptcy protection. The plan formulation phase takes place after the bankruptcy situation and precedes the turnaround response (see Figure 1).
Subject to local jurisdiction, a company seeking bankruptcy protection has a specific number of days to present its reorganization plan, which has to be accepted by a precise number of creditors within each class of creditors3. In Brazil, the reorganization plan must be submitted within 60 days after the decision granting the judicial reorganization (Lei no. 11.101, 2005). Together with the creditors, the plan must also be confirmed by the court. A court can confirm a reorganization plan only if it believes that the confirmation "is not likely to be followed by the liquidation, or the need for further financial reorganization, of the debtor or any successor to the debtor under the plan, unless such liquidation or reorganization is proposed in the plan" (section 1129(a)(11) of the US Bankruptcy Code, Confirmation of Plan, 2019). This type of assessment is performed in Brazil by the judge responsible for reviewing the request for judicial recovery (see, for instance, Vaz, 2018). This is generally referred to as the feasibility test. The test does not require the guaranteed success of the plan. The firm must show only that there is reasonable assurance of compliance with the terms of the plan. In other words, the test requires a demonstration of the likelihood of the plan will be accomplished, not its success (Baldiga, 1996).
In fact, a good reorganization plan is not itself a guarantee to uplift a company in crisis. Macroeconomic factors, increased competition, or even the failure of the plan's execution can compromise the intended reorganization. However, the relevance of the present investigation should not be underestimated; the reorganization plan is the heart of the process of reorganization bankruptcy. A reorganization plan is the roadmap for a firm's turnaround, as expressed by its managers. It is also the core element whose feasibility the court assesses to decide on the request for reorganization. In this sense, our study makes an explicit link between strategy and bankruptcy (Daily, 1994; Sheppard, 1994; Trahms et al., 2013). More specifically, the reorganization plan is important because it brings empirical evidence on...
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