Transparency around exit costs across Europe Karin S. Thorburn Dartmouth College

06/12/12Karin Thorburn, Dartmouth College2 Objective of bankruptcy Restructure economically viable firms Restructure economically viable firms Terminate unprofitable operations and reallocate assets to higher-value use Terminate unprofitable operations and reallocate assets to higher-value use Do this as cost-efficiently as possible Do this as cost-efficiently as possible

06/12/12Karin Thorburn, Dartmouth College3 Bankruptcy costs Direct costs Direct costs –Lawyers, bankers, court hearings Indirect costs Indirect costs –Decline in sale, loss of employees, etc. Inefficient allocation of assets Inefficient allocation of assets –Continuation versus liquidation –Fire sales Delayed filing and risk-shifting incentives Delayed filing and risk-shifting incentives Predictability/transparency of proceedings Predictability/transparency of proceedings

06/12/12Karin Thorburn, Dartmouth College4 EU insolvency regulation Regulation on Insolvency Proceedings Regulation on Insolvency Proceedings –Rules for cross-country proceedings Main insolvency proceedings in member state where firm has its “center of main interest” Main insolvency proceedings in member state where firm has its “center of main interest” Secondary proceedings in other member countries, limited to winding up assets and run parallel to main proceedings Secondary proceedings in other member countries, limited to winding up assets and run parallel to main proceedings –No harmonization of bankruptcy law between different EU countries

06/12/12Karin Thorburn, Dartmouth College5 Bankruptcy systems Reorganization codes (US, France) Reorganization codes (US, France) –Formal framework to renegotiate claims –Incumbent management retains control –Equityholder friendly Auction codes (Sweden, UK) Auction codes (Sweden, UK) –Sale of the firm in a mandatory auction –Creditor rights at the forefront

06/12/12Karin Thorburn, Dartmouth College6 France Court appoints an administrator Court appoints an administrator Objectives are firm continuation, job preservation and, third, creditor claims Objectives are firm continuation, job preservation and, third, creditor claims Automatic stay, super-priority debt Automatic stay, super-priority debt Creditors are removed from process Creditors are removed from process Tax and employee claims take priority to proceeds from secured assets Tax and employee claims take priority to proceeds from secured assets

06/12/12Karin Thorburn, Dartmouth College7 Germany 3-month grace period from creditors 3-month grace period from creditors Administrator contrives a reorganization plan Administrator contrives a reorganization plan Approval from creditors by majority vote Approval from creditors by majority vote Court may cram down on dissenting creditors Court may cram down on dissenting creditors

06/12/12Karin Thorburn, Dartmouth College8 The UK Secured creditor appoints receiver Secured creditor appoints receiver Receiver looks after the interests of the secured creditor Receiver looks after the interests of the secured creditor Receiver decides whether to restructure firm or sell assets Receiver decides whether to restructure firm or sell assets No automatic stay or super-priority financing No automatic stay or super-priority financing

06/12/12Karin Thorburn, Dartmouth College9 Sweden Mandatory auction of firm as a going concern or piecemeal Mandatory auction of firm as a going concern or piecemeal Automatic stay of debt and super- priority financing Automatic stay of debt and super- priority financing Buyer decides whether to retain incumbent management Buyer decides whether to retain incumbent management Payment in cash Payment in cash

06/12/12Karin Thorburn, Dartmouth College10 Reorganization code Pros: Pros: –Encourages management to file early Cons: Cons: –Joint negotiation of firm value, use of assets and creditor payoffs risks prolong the bankruptcy procedure –Inefficient continuations –Less transparent

06/12/12Karin Thorburn, Dartmouth College11 Auction code Pros: Pros: –Assets are valued by the market –Highest bidder decides use of assets –Cash allows payoffs following APR Cons: Cons: –Asset fire sales –Delayed filing and excessive risk-shifting

06/12/12Karin Thorburn, Dartmouth College12 Direct and indirect costs Swedish auctions speedy—2 months— and relatively low cost (Thorburn 00) Swedish auctions speedy—2 months— and relatively low cost (Thorburn 00) UK bankruptcy higher direct costs (Franks and Sussman 04) UK bankruptcy higher direct costs (Franks and Sussman 04) Lowest debt recovery rates in France, highest in UK and Sweden (Davydenko-Franks 04, Thorburn 00) Lowest debt recovery rates in France, highest in UK and Sweden (Davydenko-Franks 04, Thorburn 00)

06/12/12Karin Thorburn, Dartmouth College13 Inefficient continuation and liquidation France: too much continuations? France: too much continuations? UK, Germany: too many liquidations? UK, Germany: too many liquidations? Sweden: buyer decides, so no real distortion of incentives Sweden: buyer decides, so no real distortion of incentives Most liquidations in French bankruptcy (Kaiser 96, Davydenko-Franks 04) Most liquidations in French bankruptcy (Kaiser 96, Davydenko-Franks 04) Auctioned firms perform well (Eckbo- Thorburn 03) Auctioned firms perform well (Eckbo- Thorburn 03)

06/12/12Karin Thorburn, Dartmouth College14 Asset fire sales UK, Sweden: depressed prices? UK, Sweden: depressed prices? Managers repurchase assets in period of industry distress (Stromberg 00) Managers repurchase assets in period of industry distress (Stromberg 00) Secured creditors provide liquidity to competing bidders (Eckbo-Thorburn 04) Secured creditors provide liquidity to competing bidders (Eckbo-Thorburn 04) Auction prices do not vary with fire-sales variables in continuation sales (Eckbo- Thorburn 06) Auction prices do not vary with fire-sales variables in continuation sales (Eckbo- Thorburn 06)

06/12/12Karin Thorburn, Dartmouth College15 Delayed filing UK, Sweden: excessive risk-shifting? UK, Sweden: excessive risk-shifting? France: encourages early filing? France: encourages early filing? Managerial incentives to retain control benefits (Eckbo-Thorburn 03) Managerial incentives to retain control benefits (Eckbo-Thorburn 03) Personal liability for late action Personal liability for late action

06/12/12Karin Thorburn, Dartmouth College16 Out-of-court solutions France: many workouts? France: many workouts? UK, Sweden: few workouts? UK, Sweden: few workouts? Similar rates of bankruptcy filing for defaulted firms across UK, Germany and France (Davydenko-Franks 04) Similar rates of bankruptcy filing for defaulted firms across UK, Germany and France (Davydenko-Franks 04) German banks form bank pools to facilitate voluntary workouts (Brunner- Krahnen 04) German banks form bank pools to facilitate voluntary workouts (Brunner- Krahnen 04)

06/12/12Karin Thorburn, Dartmouth College17 Recent reform EU encourages its member countries to strengthen their provisions for reorganization EU encourages its member countries to strengthen their provisions for reorganization Recent reforms in many European countries undermine creditor rights and decrease transparency in exit costs Recent reforms in many European countries undermine creditor rights and decrease transparency in exit costs US development towards using market mechanisms (Baird-Rasmussen 04) and increased transparency US development towards using market mechanisms (Baird-Rasmussen 04) and increased transparency

06/12/12Karin Thorburn, Dartmouth College18 Summary Different bankruptcy codes impose different costs on distressed firms Different bankruptcy codes impose different costs on distressed firms French reorganization code appears to fail successfully restructuring firms French reorganization code appears to fail successfully restructuring firms Swedish auction code seems relatively low- cost and transparent, along with UK code Swedish auction code seems relatively low- cost and transparent, along with UK code Is reform in Europe going in the wrong direction? Is reform in Europe going in the wrong direction?