We find an average overall recovery rate of 34 percent in our sample. This is consid- erably lower than what is reported in the Chapter 11 studies, ranging from 51 percent (Franks and Torous (1994)) to over 70 percent (Weiss (1990), White (1984)). Moreo- ver, White (1984) reports the average overall recovery rate in Chapter 7 to be 14 per- cent and, in particular, that of unsecured creditors to be only 4 percent. Thus, it is im- possible to assess whether the average payout in bankruptcy over all U.S. bankrupt firms is higher or lower than in our sample.
An alternative is to compare the Chapter 11 cases to the post-filing going concern sales in our sample and the Chapter 7 bankruptcies to the piecemeal liquidations. We find a mean recovery rate of 38 percent among the post-filing going concern sale, which is still much lower than the payoff to creditors of Chapter 11 firms. On the other hand, the average overall recover rate of 26.1 percent for firms liquidated piecemeal is higher than the payoffs reported by White for Chapter 7 firms.
The higher Chapter 11 overall recovery rates are reflected in differences in the payoffs to different types and classes of creditors. For instance, Franks and Torous (1994) report bank recovery rates of 86.4 percent in Chapter 11, compared to a bank recovery rate of 69.0 percent over all bankruptcies in our sample and 77.6 percent for the post-filing sales. Not surprisingly, the most dramatic differences are found in the recovery rates of junior creditors, where Franks and Torous document an average pay- off of 28.9 percent, compared to 2.0 percent for our total sample as well as for the
Turning to the Finnish study, Sundgren (1995) finds an average recovery rate of 35.1 percent, which is similar to that in our sample. Sundgren does not report recovery rates for different classes or types of debtholders.
Insolvensutredningen (1992) provides numbers on the total payout and total debt, implying a value-weighted overall recovery rate of 25 percent in their sample. This is slightly lower than the corresponding value-weighted overall recovery rate of 32 per- cent in our sample. However, Insolvensutredningen finds a size effect with respect to the recovery rates, indicating that the difference in payout between their and this study probably reflects the difference in firm size between the two samples.
5.5 Direct costs of bankruptcy
Our study documents significant direct costs of bankruptcy. When measured as a frac- tion of the assets in bankruptcy the direct costs amount on average to 19.4 percent, and when related to the pre-bankruptcy assets the direct costs amount to 5.9 percent. Because of the endogeneity problems related to the realized bankruptcy asset values, the latter probably provides a more correct measure of the actual costs.
Some critics of Chapter 11 claim that the direct bankruptcy costs are much smaller in a liquidation auction procedure. At first sight, our data does not support this view. Measures of average direct costs in Chapter 11 range from 2.8 to 3.9 percent of pre- bankruptcy book assets (Weiss (1990), Betker (1995)), which is lower than the direct costs found in this study, regardless of whether we compare with the full sample (5.9 percent) or with the subset of post-filing going concern sales (7.0 percent). However, to the extent that direct costs do not increase proportionally with asset size, e.g. would there be substantial fixed costs, this comparison is not valid since the Chapter 11 firms studied are many times larger than the firms in this study.
Sundgren (1995) reports the administrative expenses as a proportion of assets in bankruptcy, finding average direct costs of 15.3 percent. Considering the fact that his sample technique probably excludes most of the pre-filing going concern sales, which in our sample have direct costs related to assets in bankruptcy of 33.6 percent, this magnitude of costs is comparable to this study.
5.6 Outcome of bankruptcy
One of the most striking findings in this study is that almost three quarters of the op- erations of the bankrupt firms are kept as a going concern in a new legal entity41, 42.
41
Restricting attention to the firms that still have operations when entering bankruptcy, the cor- responding figure is 66 percent.
42
In our definition of a going concern sale we include split going concern sales, where the firm’s divisions are sold separately to different buyers. One could argue that these sales rather resemble a
The survival rate in our sample is not lower than what have been found in studies of firms filing for Chapter 11, which is somewhat surprising since most firms in the U.S. that are liquidated piecemeal are presumed to file for Chapter 7. For instance, White (1984) finds in her sample of 64 large firm Chapter 11 cases that 41 percent of the firms adopt reorganization plans and that another 23 percent of the firms are sold as going concerns, ending up with a total survival rate of 64 percent. Flynn (1989) ex- amines 2,400 small firms filing for Chapter 11 between 1979 and 1986. He estimates that only 17 percent of the filing firms manage to adopt reorganization plans. Moreo- ver, Flynn finds that the adoption rate is increasing over time. However, he does not provide any statistics on the frequency of going concern sales.
Despite the fact that the Finnish bankruptcy code was similar to the Swedish code, Sundgren (1995) finds a survival rate of only 29 percent in his sample, which is consid- erably lower than the survival rate of 74 percent in this study. Differences in methodol- ogy probably account for much of the difference. For example, Sundgren’s sampling criterion in principle excludes the pre-bankruptcy going concern sales, which account for 23 percent of the going concern sales or 18 percent of all firms in our sample. Moreover, Sundgren defines a going concern sale as when “most of the bankrupt’s as- sets are sold to one successor”, and it is not clear how this relates to our definition43.
5.7 Post-bankruptcy performance
Besides the high survival rate, another important finding of this study is that over a third of the surviving firms file for bankruptcy a second time within 4 years after the initial reorganization. In particular, almost half of the surviving firms controlled by the pre-bankruptcy owner file for bankruptcy again. The surviving firms emerge and re- main much more highly levered than the industry median. Furthermore, two years after bankruptcy 67 percent of the firms still alive at that time have a lower return on assets and 78 percent have a higher debt to asset ratio than the contemporaneous industry medians.
The high bankruptcy incidence, the substantial leverage and the sub-standard op- erating performance of the continued operations compared to the contemporaneous industry medians are consistent with previous research on firms emerging from Chap- ter 11. Yet, we observe these same patterns under a different institutional setting, where many of the proposed explanations for these phenomena are not present, such as the presumed bargaining advantage of incumbent managers in Chapter 11.
piecemeal liquidation. However, changing the classification of the 8 split going concern sales (3% of the total) would not affect our conclusions
In a study of 197 public firms which emerged from Chapter 11 Hotchkiss (1995) finds that over 40 percent of the firms experience operating losses in the three years following bankruptcy and that one third of the firms need to restructure again after a median time of 3.8 years. Moreover, Gilson (1993) finds that 65 percent of the reor- ganized firms in his sample emerge from Ch 11 more highly levered than their industry median and a quarter of them has to restructure their debt a second time.
Hotchkiss also shows that the longer the incumbent management team stays in control in the Chapter 11 reorganization, the worse the post-bankruptcy performance of the emerging firm. Perhaps this piece of evidence could be compared to our finding that surviving firms which are controlled by the pre-bankruptcy owner have a signifi- cantly higher bankruptcy filing rate than other surviving firms.
The simple fact that the surviving firms perform worse than their industry median does not imply that they should not have survived. A firm can have lower profits than the rest of the industry and still earn its cost of capital. For example Alderson and Bet- ker (1995) show that nearly 80 percent of firms emerging from Chapter 11 earn their cost of capital when using S&P 500 as the risk adjusted rate of return, despite sub- standard accounting profitability44.