Of bail-outs and bankruptcies: An empirical study of distressed debt restructurings in Germany

Abstract

A firm that needs to restructure its debt in order to avoid or remedy a default essentially faces a choice between two alternatives. It may privately renegotiate the affected debt claims in a workout or file a formal bankruptcy petition to resolve financial distress through an in-court proceeding. Financial scholars have long been engaged in discussing the relative merits and shortfalls of both alternatives. Bankruptcy, in general, has the advantage that it protects a distressed debtor from the ‘harassment’ of creditors and mitigates hold-out and information problems among different classes of claimholders [e.g. (1982), (1991)]. In a private workout, on the other hand, firms are likely to avoid much of the direct and indirect costs associated with a formal proceeding [e.g. (1989), (1990)]. This suggests that a firm will choose the workout option if settling this way leaves the firm appreciably more valuable and if unanimous consent among all claimants is feasible. If, however, the affected parties cannot agree on how to share the alleged benefits associated with settling out-of-court, then formal bankruptcy may be the dominant option even though the combined wealth of all parties is ultimately lower [e.g. (1989), (1989)]. Yet, despite these relatively precise predictions provided by theory, empirical results have remained sparse and inconclusive. In particular, there exists little evidence on how firms actually choose between an in- and out-of-court resolution of distress, and to what extend firm value is affected by that choice. Moreover, we currently know little about how the choice between workout and bankruptcy is affected by the design of national bankruptcy legislation. Much of this lack of evidence is attributable to the difficulty to obtain exhaustive data.¹ This holds especially for corporate Germany where, until fairly recently, most of the restructuring activity occurred without public disclosure.²

I would like to thank Wolfgang Bühler, Dietmar Harhoff, Christoph Kaserer, Colin Mayer, Ken Okamura, Luis Rodrigues, Bernd Rudolph, Gerhard Schröck, Oren Sussman, and Hannes Wagner for helpful discussions. The study in this chapter has also benefited from conference and doctoral seminar presentations at the 9th Conference of the Swiss Society for Financial Market Research, Zürich 2006, the Annual Conference on Corporate Strategy (ACCS), Berlin 2006, the 4th Portoguese Finance Network International Conference, Porto 2006, the European Finance Association Meeting, Zürich 2006, the German Finance Association (DGF) Annual Meeting, Oestrich-Winkel 2006, the University of Munich (2005), the Technical University of Munich (2005), and the University of Oxford (2006). I would like to thank two anonymous referees for their thoughtful comments

I am only aware of two studies that more or less directly address this issue, see Gilson, John, and Lang (1990) and Asquith, Gertner, and Scharfstein (1994).

See Kaiser (1996), pp. 73–74 and references quoted therein