Sandeep Dahiya

Financial Distress and Bank Lending Relationships

We use a unique data set of bank loans to examine the wealth effects on lead lending banks when their borrowers suffer financial distress. We find a significant negative announcement return for the lead lending bank when a major corporate borrower announces default or bankruptcy. Banks with higher exposure to the distressed firm have larger negative announcement-period returns. The existence of a past lending relationship with the distressed firm results in larger wealth declines for the bank shareholders. Finally, financial distress also has a significant negative effect on borrowers returns.

Debtor-in-Possession Financing and Bankruptcy Resolution: Empirical Evidence

Debtor-in-Possession (DIP) financing is a unique form of enhanced secured financing that is granted to firms filing for reorganization under Chapter 11 of the US Bankruptcy Code. Opponents of DIP financing argue that such financing can lead to overinvestment, i.e., excessive investment in risky, (even negative NPV) projects. Alternatively, DIP financing can allow funding for positive NPV projects. Related to this is the question of whether DIP financing is related to a quicker resolution of the bankruptcy process. We examine these issues empirically. Using a large sample of bankruptcy filings, we find little evidence of systematic overinvestment. DIP financed firms are more likely to emerge from the Chapter 11 process than non-DIP financed firms. Interestingly, DIP financed firms have a shorter reorganization period; they are quicker to emerge and also quicker to liquidate. The time spent in bankruptcy is even shorter when the DIP lender also has a prior lending relationship with the firm.

Staged Investments in Entrepreneurial Financing

Venture capitalists deliver investments to entrepreneurs in stages. This paper shows staged financing is efficient. Staging lets investors abandon ventures with low early returns, and thus sorts good projects from bad. The primary implication from staging is that it is efficient to invest more in later rounds. The model yields a number of predictions on how the ratio of early to late round financing varies with uncertainty, the outside options of both parties, the value of the venture, the costs of investment, and project difficulty. We test these predictions against data on venture capital financings and find significant empirical support for the theory.

Who Survives? A Cross-Country Comparison

How capital structure, dividend policy and corporate governance vary across countries has been the focus of recent studies, but how resources are reallocated in response to poor performance has not received as much attention. This paper argues that the market for corporate control and the formal bankruptcy/liquidation processes of a country are two key mechanisms through which corporate assets are reallocated. Ideally, an economy would only allow the best users of economic resources to retain the right to use those assets and sub-optimal use would result in either a take-over by a more proficient owner or an asset sale. We present preliminary evidence that equity market delistings occur more frequently in countries with strong shareholder rights. Furthermore, both strong creditor and shareholder rights increase the use of bankruptcy, relative to acquisitions, as a mechanism to resolve financial distress. We also present preliminary evidence that these mechanisms are not as effective in Japan.

Litigation Exposure, Capital Structure, and Shareholder Value: The Case of Brooke Group

Abstract We examine value creation and destruction in the tobacco industry due to the radical litigation strategy of Brooke Group CEO Bennett LeBow. Brooke Group had tiny market share, low margins, high leverage and highly concentrated management ownership. Beginning in 1996, the firm reached settlements in lawsuits brought against all cigarette companies by class action plaintiffs and US state governments. Brooke Groups actions, which included promises to cooperate in litigation against its rivals, spurred other companies to reach settlements on less favorable terms. These events led to massive wealth destruction within the industry but impressive returns for shareholders of Brooke Group.

Corporate Governance and Loan Syndicate Structure

Firms with greater shareholder rights have higher risk-shifting incentives. Such firms should have more concentrated loan syndicates to ensure more intensive monitoring. In the United States, the second generation antitakeover laws reduced the shareholder rights significantly. We find that loan syndicates became significantly less concentrated after the passage of these laws. Our results are robust to legal, institutional and political economy considerations that affect these tests. Additional tests support the risk-shifting channel. Our results have important implications for understanding how corporate governance causally affects financial contracting and creditor control in firms.

A Theoretical Framework for Evaluating Debtor-in-Possession Financing

The US bankruptcy code provides enhanced priority and security features to debtor-in-possession (DIP) loans which can be obtained from a lender with whom the borrower may have no past lending relationship. The enhanced priority of DIP financing, and the choice of a DIP lender, significantly impact the investment decisions made by the firm. We show DIP loans from an existing lender leads to a higher level of investment. We also show that a higher priority of DIP financing also leads to higher investment by the firm. A bankruptcy judge should take these incentives into account when approving the DIP loan.

Firm Opacity Lies in the Eye of the Beholder

Given the central role of firm opacity in most finance theories, empirical proxies that identify firm opacity correctly should allow for more powerful tests of these theories. The last decade has seen adoption of several different empirical proxies that aim to capture firm opacity. However, there is no study that has compared all of these measures. In this paper, we investigate how these different measures are related to each other. We classify the main empirical measures of firm opacity into three broad categories; those based on behavior of stock returns, those based on information produced by intermediaries such as stock analysts, and those based on market microstructure. Since opacity of depositary institutions has been focus of a number of recent studies, it provides a natural laboratory to test these different proxies. Our results show that while there is only a limited correlation among various opacity measures, most of them indicate that banks are less opaque compared to non-banks. Our failure to find consistent evidence on bank opacity suggests that the results are highly dependent on the opacity measure employed by the researcher. To measure the effectiveness of various opacity proxies, we use credit rating initiation as a significant shock to the firm information environment. We adopt a difference-in-difference approach, by comparing newly rated firms with “unchanged” firms, i.e. already rated or unrated firms. Our results suggest that the number of analysts and the price impact (as measured by the Amihud’s (2002) ratio) appear to be the most reliable proxies for firm opacity.