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We have observed that a majority of the firms keep their assets as a going concern through bankruptcy and emerge under a new corporate identity. In this section, we de- scribe the post-bankruptcy performance and financial characteristics of the “surviving firms”, defined as the corporations which acquire and continue the operations of a bank- rupt firm. We relate the measures to the contemporaneous industry median. Moreover, we control for differences in firm characteristics depending on whether the pre- bankruptcy manager retains control of the operations or if a change in ownership occurs.

Among the 195 going concern sales in our sample, we can identify the surviving firm in which the pre-bankruptcy operations are continued following the asset transfer in a total of 147 cases (i.e. approximately three out of four sales)28. 14 of these (9.2 percent) are going concern sales taking place more than two weeks prior to bankruptcy, 18 cases (12.2 percent) are sales 14 days or less prior to bankruptcy, 6 of them (3.4 percent) are split sales and in the remaining 109 cases (74.1 percent) the operations are sold in one piece at some point in time following bankruptcy filing. Thus we have a slight over- representation of post-filing going concern sales in this follow-up sample. The proportion of pre-bankruptcy owner acquisitions is 53.1 percent, which corresponds closely to the total sample proportion of 53.8 percent.

Because of the 6 split going concern sales, where there are different buyers of two or more divisions of the firm, we end up with a sample of 153 surviving firms. 108 firms of these (70.6 percent) are corporations which have no business activities prior to the acquisition of the bankrupt firm’s assets and 42 corporations (27.5 percent) merge the operations of the bankrupt firm into their current business activities. The remaining 3 acquiring firms are sole proprietorships, for which no financial data can be obtained.

Table 18 presents the frequency of a second bankruptcy filing for the surviving firms. Within 4 years after the “resolution” of financial distress, defined as the date of the transfer of the assets to a new firm when known (127 cases), or otherwise the date of the

bankruptcy filing (26 cases), 37.9 percent of the surviving firms file for bankruptcy again. In particular, 48.0 percent of the firms controlled by the pre-bankruptcy owner file for bankruptcy a second time, while 26.5 percent of the firms controlled by new owners file, the difference being statistically significant on the 1 percent level. We find no significant difference in the bankruptcy filing rate depending on whether the surviving firm has operations prior to the acquisition of assets or not.

Table 18. Bankruptcy frequency among surviving firms

The table comprises 153 “surviving firms”, in which the pre-bankruptcy operations are continued under a new corporate identity. Resolution is defined as the date of the transfer of the assets to a new firm when known (127 cases) or otherwise the date of the bankruptcy filing (26 cases). The numbers reported are the proportion of bank- ruptcy filings of all firms (firms with new owners / firms run by the pre-bankruptcy owner). aa (a) indicates a significant difference between firms controlled by new owners and pre-bankruptcy owners at the 1% (5%) level, using a Mann-Whitney U - Wilcoxon rank sum W test.

Time after resolution for second bankruptcy filing

Proportion firms filing for bankruptcy All firms (new / pre-bankruptcy owner)

Cum. proportion filing for bankruptcy All firms (new owner / pre-bankr. owner) 0 - 12 months .098 (.059 / .130) .098 (.059 / .130)

13 - 24 months .170 (.088 / .246)a .268 (.147 / .377)aa 25 - 36 months .065 (.088 / .052) .333 (.235 / .429)a 37 - 48 months .046 (.029 / .052) .379 (.265 / .480)aa

As a crude comparison we calculate the bankruptcy frequency for a control sample comprising all Swedish corporations with more than 20 employees alive on January 1, 1991, in total some 15,000 firms. During a 4 year period, between January 1, 1992 and December 31, 1995, 11 percent of the firms in the control sample file for bankruptcy. Thus, even the surviving firms run by new owners seem to have less than half of the survival rate of the corporate population.

Furthermore, most of the bankruptcy filings of the 153 surviving firms take place during the first two years following the resolution date. Within the first 12 months fol- lowing resolution, 13.0 percent of the surviving firms controlled by the pre-bankruptcy owner file for bankruptcy, and within the following 12 months another 24.6 percent of these firms file. During the same time period the filing rate for surviving firms controlled by new owners is significantly lower, 5.9 and 8.8 percent respectively. However, during the third and fourth year after resolution the average bankruptcy filing rate is of the same magnitude for the two groups of surviving firms.

The operations which are sold as a going concern undergo substantial restructurings in connection with the assets transfer to a new corporate entity. To investigate the changes in firms characteristics through bankruptcy, we compare pre- and in-bankruptcy characteristics of the operations with data from the first annual report after resolution for the surviving firm.

We first restrict attention to the 108 cases where the bankrupt firm’s operations are transferred to a firm that have no business activity prior to the acquisition of the bank- rupt firm's assets. Thereby we avoid that the comparison is blurred by other previous activities that the acquiring firm might have engaged in. 23 of these acquiring firms are immediately excluded; 20 firms file for bankruptcy again before having prepared any post-acquisition financial statement, 1 firm lacks pre-bankruptcy financial data and 2 firms are sole proprietorships for which no financial data is obtainable. We also exclude 3 firms that aqcuire only a part of the bankrupt firm’s operations in a split going concern sale. Finally, we require that the first post-acquisition financial statement is prepared between 3 and 18 months after the going concern sale, eliminating another 7 firms from the analysis. Thus, we end up with a sub-sample of 75 newly started corporations which acquire and continue the operations of a filing firm.

Table 19. Changes in firm characteristics through bankruptcy

The table comprises 75 surviving firms which have no business activity prior to the acquisition of the bankrupt firm’s operations, bought as a going concern in one piece. Values are book values, deflated to 1991 prices and adjusted to an annual basis. Gross margin is defined as earnings before interest, taxes and depreciation (EBITDA) over total sales. Return on assets is defined as earnings before interest and taxes (EBIT) over total assets. Relative interest is defined as financial expenses over total interest bearing debt. The table presents changes from the bankrupt firm’s last financial statement prior to resolution, to the surviving firm’s first financial statement dated 3 to 18 months after resolution. Resolution is defined as the date of the transfer of the assets to a new firm (63 cases) or when this date is not known the date of the bankruptcy filing (15 cases). The bankruptcy filing measures in the last two rows exclude 5 firms which sold their operations prior to filing. aa (b) indicates a significant difference form zero at the 1% (10%) level using a Wilcoxon matched-pairs signed-ranks test. Column 5 shows a 2-tailed P- value for the equality of the medians between new and pre-bankruptcy owners, from a Mann-Whitney U - Wilcoxon rank sum W test.

Firm characteristic All firms Mean (median) New owner Mean (median) Pre-bankruptcy owner Mean (median) P-value for equality of medians

Changes from prior to bankruptcy:

Number of firms 75 38 37

Relative change in sales -.497aa (-.512) -.512aa (-.514) -.483aa (-.512) .791 Relative change in total assets -.438aa (-.476) -.485aa (-.569) -.390aa (-.422) .112 Relative change in no. of employees -.478aa (-.526) -.445aa (-.444) -.512aa (-.547) .719 Absolute change in gross margin .052aa (.030) .054b (.031) .050b (.029) .883 Absolute change in return on assets .096aa (.042) .104b (.045) .089b (.038) .888 Relative change in total debt -.363aa (-.444) -.423aa (-.494) -.301aa (-.418) .107 Absolute change in debt to asset ratio .001 (.005) -.014 (.005) .018 (.030) .791 Change in relative interest -.006 (-.008) -.008 (-.012) -.004 (-.006) .535

Changes from bankruptcy filing:

Relative change in total debt -.355aa (-.499) -.432aa (-.614) -.272aa (-.451) .090 Relative change in floating charge -.294aa (-.688) -.519aa (-.792) -.069 (-.294) .050

The pre-bankruptcy owner retains control of the operations for 37 of these firms, while the operations of 38 firms change owner in bankruptcy. Table 19 presents the changes in firm characteristics from the bankrupt firm’s last financial statement prior to the asset transfer, to the surviving firm’s first financial statement following the asset transfer29.

The operations of the surviving firms are significantly smaller than the pre- bankruptcy operations. Total sales, total assets and the number of employees are reduced to almost half of their pre-bankruptcy size, irrespective of who controls the surviving firm. Moreover, the profitability of the restructured operations are higher: the average gross margin increases by 5 percentage points and the return on assets with 10 percent- age points. This pattern is similar for new and pre-bankruptcy owners, although the reduction in total assets is slightly larger for firms controlled by new owners.

Despite somewhat similar restructurings on the asset side, surviving firms controlled by new owners reduce the total debt significantly more than do firms controlled by pre- bankruptcy owners. For example, new owners reduce the firm’s debt on average by 43 percent from bankruptcy filing compared to a 27 percent reduction for pre-bankruptcy owners, or by 42 and 30 percent respectively compared to the last financial statement prior to bankruptcy. As a result, pre-bankruptcy owners experience on average a slight increase in the debt to asset ratio, while new owners on average lower the debt level. Moreover, firms controlled by new owners reduce the floating charge debt to less than half of its pre-bankruptcy level, while firms controlled by the pre-bankruptcy owner on average reduces it by only 7 percent.

We now turn to the long-run performance of the surviving firms, summarized in ta- ble 20. The sample used for this analysis consists of all acquiring firms for which at least one post-resolution financial statement is available. Thus to the 86 firms that have no business activities prior to the acquisition of the bankrupt firm’s assets we add 30 firms that merge the operations of the bankrupt firm into their current business activities30, 31.

Of the resulting 116 firms, 43.1 percent are run by their pre-bankruptcy owners, which is less than in the total sample. This comes from the higher bankruptcy incidence among surviving firms controlled by the pre-bankruptcy owner, which leads to a larger proportion of the pre-bankruptcy owner controlled surviving firms never preparing any financial statement compared to the surviving firms run by new owners.

29

In fact, we use the date of the asset transfer when known and else the bankruptcy filing date. However, these two events take place so close in time that they refer to the same financial statements.

30

Of the in total 42 firms that merge the operations of the bankrupt firm into their current busi- ness activities, 11 went bankrupt again before having prepared their first post-acquisition financial statements and one is a sole proprietorship, leaving us with 30 firms for the analysis.

31

We compared for differences in the development of firm characteristics between the two groups of firms, but found none.

Table 20. Post-bankruptcy real characteristics

The table comprises 116 surviving firms in which the pre-bankruptcy operations are continued after bankruptcy. Gross margin is defined as earnings before interest, taxes and depreciation over total sales. Return on assets is defined as earnings before interest and taxed over total assets. Investments are defined as percentage change in the book value of property, plant and equipment plus depreciation. Resolution is defined as the date of the trans- fer of the assets to a new firm when this date is known (91 cases) or otherwise the date of the bankruptcy filing (25 cases). The numbers are medians, based on book values which are deflated to 1991 prices and adjusted to an annual basis. For the measures 1 year after resolution we use the first financial statement dated 3 to 18 months after the resolution date. For the measures 2 (3) 4 years after resolution we use the financial statement dated 19- 30 (31-42) 43-54 months after the resolution date, or, when there are several financial statements in that period, the financial statement closest to 24 (36) 48 months after resolution. Columns 2-4 report the sample median and, in parenthesis, the absolute deviation from the 1 digit SIC code level weighted contemporaneous industry me- dian. aa (a) b indicates a significant difference from the industry median at the 1% (5%) 10% level, based on a Wilcoxon matched-pairs singed-ranks test. Column 5 shows a 2-tailed P-value for the equality of the industry adjusted medians between new and pre-bankruptcy owners, from a Mann-Whitney U - Wilcoxon rank sum W test.

Firm characteristic All firms New owner Pre-bankruptcy owner

P-value for eq. of medians

1 year after resolution:

Number of firms 109 61 48

Gross margin .064 (.014) .064 (.008) .064 (-.002) .706 Return on assets .081 (-.019) .073 (-.018) .097 (.009) .381

2 years after resolution:

Number of firms 95 54 39

Gross margin .047 (-.013) .053 (-.006) .047 (-.010) .791 Return on assets .069 (-.031)aa .069 (-.042)aa .071 (-.058)aa .981 Relative growth in sales .088 (.098)aa .202 (.212)aa .037 (.041) .144 Investments .220 (.110)aa .273 (.175)aa .161 (.047)aa .066 3 years after resolution:

Number of firms 86 46 37

Gross margin .061 (-.009) .066 (-.011) .061 (-.009) .741 Return on assets .084 (-.036)aa .089 (-.039)b .084 (-.043)a .608 Relative growth in sales .031 (.031) .019 (-.007) .088 (.008) .775 Investments .230 (.100)aa .272 (.139)aa .183 (.053)aa .139

4 years after resolution:

Number of firms 40 24 16

Gross margin .066 (-.014) .091 (.016) .067 (-.011) .762 Return on assets .090 (-.040) .109 (.020) .110 (-.056) .586 Relative growth in sales -.007 (-.027) -.017 (-.046) -.056 (-.047) .732 Investments .172 (.042)a .422 (.338)aa .114 (-.037) .001

The first year following resolution the performance of the surviving firms is well in line with that of the industry. The sample firms have a median gross margin of 6.4 per- cent, which is slightly higher (1.4 percentage points) than the contemporaneous weighted

industry median32, and a return on assets of 8.1 percent, which is slightly below the industry median.

During the second to fourth year following the asset transfer, the surviving firms have a slightly lower gross margin than the industry median and a significantly lower return on assets. For instance, the second year following bankruptcy the median gross margin of the surviving firms is around 1 percentage point below the industry median and the return on assets some 3 to 5 percentage points lower.

Recall that 10 percent of the surviving firms file for bankruptcy again within one year following the initial asset transfer, and 27 percent within two years. Since no finan- cial data is available for most of these filing firms, the profitability of the surviving firms will be overstated, and in particular for the group run by their pre-bankruptcy owners. By the same token, we can expect to observe an improved performance during the third and fourth year of post-bankruptcy operations, after failing firms have gone bankrupt and disappeared from the sample. This latter effect is, however, not evident from our data. On the other hand, many firms are sold with the Wage Guarantee Act covering the wage costs for a few months after the transfer of the operations, which may result in a seem- ingly better result during the first period following resolution.

During the second post-bankruptcy year of operations, surviving firms controlled by new owners have a significantly higher median growth in sales than the industry me- dian; 20.2 percent vs. -1 percent. Firms controlled by post-bankruptcy owners grow also faster than the industry median, although by only 4 percentage points and not statistically significant. The third year, surviving firms grow in line with the industry median, to fall slightly below the industry median in the fourth year of post-bankruptcy operations.

We test the significance of the observed differences in real firm characteristics be- tween surviving firms controlled by new versus pre-bankruptcy owners, finding no sig- nificance for any of these characteristics at conventional levels.

Furthermore, the surviving firms have a significantly higher investment rate, defined as the percentage change in the book value of property, plant and equipment plus depre- ciation. For example, the investments amount to 22 percent the second year after bank- ruptcy and 23 percent the third year, which exceed the industry median by 11 and 10 percentage points respectively. In particular, surviving firms controlled by new owners invest significantly more than surviving firms controlled by the pre-bankruptcy owner.

We now turn to table 21 and the financial characteristics of the surviving firms to look for an explanation to the higher bankruptcy filing rate among firms controlled by pre-bankruptcy owners compared to new owners.

Table 21. Post-bankruptcy financial characteristics

32

The table comprises 116 surviving firms in which the pre-bankruptcy operations are continued. The interest cov- erage ratio, defined as earnings before taxes and depreciation plus financial income divided by financial ex- penses, is truncated at 0 and 100. Relative interest is defined as financial expenses over interest bearing debt. Resolution is defined as the transfer of assets to another corporate entity (91 cases), or when this date is not known, the bankruptcy filing (25 cases). The numbers are medians, based on book values which are deflated to 1991 prices and adjusted to an annual basis. For the measures 1 year after resolution we use the first financial statement dated 3 to 18 months after resolution. For the measures 2 (3) 4 years after resolution we use the finan- cial statement dated 19-30 (31-42) 43-54 months after resolution, or, when there are several financial statements in that period, the financial statement closest to 24 (36) 48 months after resolution. Columns 2-4 report the sam- ple median and, in parenthesis, the deviation from the 1 digit SIC code level weighted contemporaneous industry median. aa (a) b indicates a significant difference from the industry median at the 1% (5%) 10% level, based on a Wilcoxon matched-pairs singed-ranks test. Column 5 contains a 2-tailed P-value for the equality of the industry adjusted medians between new and pre-bankruptcy owners, based on a Mann-Whitney U - Wilcoxon rank sum W test.

Firm characteristic All firms New owner Pre-bankruptcy owner

P-value for eq. of medians

1 year after resolution:

Number of firms 109 61 48

Debt to asset ratio .901 (.121)aa .892 (.118)aa .927 (.159)aa .047

Proportion long term debt .345 (.045)aa _{.322 (.018) .400 (.148)}aa _.114

Proportion floating charge .346 (.161)aa .286 (.105)aa .388 (.160)aa .705 Proportion trade credit .170 (.030)a .213 (.039)aa .123 (.003) .042

Interest coverage ratio 2.47 (-.25) 2.90 (.120) 2.03 (-.814) .132 Relative interest .068 (-.002)a .052 (-.004) .088 (.023)aa .009 2 years after resolution:

Number of firms 95 54 39

Debt to asset ratio .906 (.136)aa .891 (.070)a .929 (.134)aa .024

Proportion long term debt .336 (.036)aa _{.336 (.084)}b _{.374 (.102)}a _.506

Proportion floating charge .350 (.090)aa .351 (.064)a .356 (.124)a .719 Proportion trade credit .156 (-.014) .156 (-.005) .167 (.001) .471 Interest coverage ratio 1.61 (-1.46) 2.16 (-.891) 1.27 (-2.06)aa .029

Relative interest .078 (.008)aa .070 (.017) .109 (.059)aa .007 3 years after resolution:

Number of firms 86 46 37

Debt to asset ratio .882 (.132)aa .812 (.085) .891 (.148)aa .009

Proportion long term debt .293 (.013)a _{.294 (.054) .281 (.033) .791}

Proportion floating charge .427 (.167)aa .413 (.159)aa .444 (.177)aa .314 Proportion trade credit .182 (.002) .194 (.023) .174 (.010) .670 Interest coverage ratio 2.28 (-1.32) 3.31 (-1.07) 1.68 (-2.08)a .030

Relative interest .079 (.029)aa .059 (.011)b .081 (.033)aa .291

4 years after resolution:

Number of firms 40 24 16

Debt to asset ratio .835 (.075)aa .829 (.046)a .848 (.078)aa .290 Proportion long term debt .347 (.097)a .347 (.163)b .444 (.182) .739 Proportion floating charge .275 (.055)a .258 (.126)a .320 (.086) .727 Proportion trade credit .130 (-.040) .119 (-.031) .158 (.015) .952 Interest coverage ratio 4.06 (-0.22) 4.43 (-.003) 2.86 (-2.12) .227

In interpreting the numbers, the survivorship bias discussed in relation to the real firm characteristics still applies. Since the subset of surviving firms that go bankrupt too early to submit a financial statement are excluded from the analysis, the remaining firms will overstate the financial strength of the surviving firms. Hence, we will probably tend to understate the amount of leverage of the restructured firms, in particular for the group run by their pre-bankruptcy owners. Moreover, the power of the statistical tests will decrease over time by the fact that fewer and fewer firms are included as the number of years increases.

The most striking finding in table 21 is that the surviving firms have a significantly higher debt to asset ratio than their industry median. During the first three years follow- ing resolution their median debt level range between 88 and 91 percent of assets, which is some 12 to 14 percentage points higher than the contemporaneous industry median. In particular, firms controlled by the pre-bankruptcy owner have a significantly higher debt to asset ratio than firms controlled by new owners, and this difference is persistent throughout the four years studied.

We can also measure a firm’s ability to service its debt by looking at the interest coverage ratio, i.e. the operating result plus financial income divided by financial ex- penses. The surviving firms, and in particular firms controlled by the pre-bankruptcy owner, have a significantly lower interest coverage ratio than the industry median. This is consistent both with their high debt to asset ratio and with the fact that these firms pay