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IntroductionIntroduction

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 theprocess 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 managements role in

the chapter 11 process may be an important source of bias. There are other factors

outside of managements control that affect subsequent performance.

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Trends in ManagementTrends in Management

During BankruptcyDuring Bankruptcy Over Half of the Sample Firms in the analysis have replaced their CEOs 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 isimplemented 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.

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Theoretical ModelsTheoretical 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 distressshow 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 toincreased 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.

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Theoretical Models(Contd.)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 poorinvestment decisions made in bankruptcy are reflected in the postbankruptcy

performances of firms emerging from the process.

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Trends of CompaniesTrends of Companies whowho

filedfiled chapter 11chapter 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.

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Success after BankruptcySuccess 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.

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Success afterSuccess after

Bankruptcy(contd.)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 butprofitability 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.

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ConclusionsConclusions

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 thecurrent 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 officethrough the time the projections were made.