Sris Chatterjee

Resolution of Financial Distress : Debt Restructurings via Chapter 11, Prepackaged Bankruptcies, and Workouts

This paper examines empirically a comprehensive sample of firms undertaking Chapter 11 reorganizations, prepackaged bankruptcies, and workouts. We provide evidence that the restructuring decision depends on the degree of the firms leverage, the severity of its liquidity crisis, the extent of creditors coordination, and the magnitude of its economic distress. The results complement theoretical models of debt restructuring choices. We find that economically viable firms prefer workouts. Further, prepackaged bankruptcies are used by firms that are economically viable but face immediate liquidity problems.

Coercive Tender and Exchange Offers in Distressed High- Yield Debt Restructurings: An Empirical Analysis

This study empirically examines tender and exchange offers for a recent sample of 46 high-yield debt restructurings by financially distressed firms during 1989-1992. We find significant differences between tender and exchange offers. Firms using tender offers appear to be in less financial distress than firms using exchange offers and face a more severe holdout problem as revealed by the structure of targeted debt. We find a significant level of coercion in our sample where tender offers appear to be more coercive than exchange offers. An analysis of success rates and post-offer filings of Chapter 11 indicates that coercion is effective in alleviating the holdout problem. Tender offers also experience a positive stock and bond price response to announcements. Our analysis suggests that coercion is not detrimental to bondholders, and may benefit security holders by increasing the likelihood of a less costly, out-of-court restructuring. Finally, we find that the LTV decision did not render exchange offers ineffective in restructuring debt of financially distressed firms. Solicitation of exit consents in exchange offers has increased significantly after the LTV decision.

Using Innovative Securities under Asymmetric Information: Why Do Some Firms Pay with Contingent Value Rights?

This paper provides the first theoretical explanation and the first empirical analysis of contingent value rights (CVRs), which have been used as a means of payment in acquisitions, exchange offers, debt restructurings, Chapter 11 reorganizations, and lawsuit settlements. A CVR is a put option committing to pay additional cash or securities to CVR holders, contingent on the issuers share price falling below a prespecified reference level. In this paper, we develop a model to show that CVRs can help a higher-intrinsic-value firm to reveal its firm type when the firm faces an asymmetric information problem. Our model predicts that i) when CVRs are offered along with cash or stock, the announcement period abnormal stock return is greater than that in stock offers, ii) firms facing more severe asymmetric information problems are more likely to offer CVRs to signal their firm type, and iii) firms that are relatively more cash-constrained are more likely to offer CVRs rather than cash. We test all three predictions using a sample of mergers and acquisitions. Our empirical results are consistent with the predictions of the model.

Market discipline, bank subordinated debt, and interest rate uncertainty

Abstract In a recent critique of the ‘market discipline’ literature in banking, Gorton and Santomero [ Journal of Money, Credit and Banking 22 (1990) 119–128] emphasize the need for adopting a rigorous valuation model in order to test for the existence of market discipline. They employ a standard version of the contingent claims pricing model in which firm-value risk is the only source of uncertainty. In this paper we extend their model by also incorporating interest rate uncertainty. The results reported here demonstrate the complex interaction effects arising from the joint uncertainties of firm risk and interest rate risk. No simple monotonie relationship exists with respect to interest rate uncertainty. The analysis presented in this paper is also applicable to a much wider class of debt-valuation problems and is not restricted to a specific question of banking policy.

Explaining differences in corporate capital structure : Theory and new evidence

Abstract This paper tests a theory of optimal capital structure based on three simple imperfections: (i) personal and corporate taxes; (ii) bankruptcy related costs; and (iii) transfer of wealth from unprotected creditors. In contrast to other empirical tests (most of which rely on comparative statics to devise a linear regression), we derive a testable equation explicitly from the firms value-maximizing first order condition. Our cross-sectional tests confirm earlier findings by Warner (1977) and Ang et al. (1982) that the fixed (explicit) costs of bankruptcy are not statistically significant.However, we find strong explanatory power in the marginal (implicit) costs of bankruptcy. These costs have two components. First, the data suggest that firms with high fixed-asset intensity carry heavier debt loads because of the floor that these assets create for potential bankruptcy costs to be borne by security-holders. This result explains inter-industry differences in debt-ratios found by Schwartz and Aronson (1967) and Scott (1972). It also explains some anomalies in recent tests by Bradley et al. (1984) who find a positive relationship between debt ratios and depreciation when their model predicted a negative relation. In our view, depreciation acts more asa proxy for fixed asset and less as a proxy for non-debt tax shield which Bradley et al. were analyzing. Secondly, our tests suggest that an unprotected creditor or wealth transfereffect provides additional stimulus to issuance of debt and that this stimulus is stronger than the net tax effect. Schwartz (1981) finds such distributional explanations to be both economically meaningful and worthy of further empirical research because of its potential for initiating legal reform. We modestly claim that our finding in this regard is an important first step in this research and is similar to the wealth-transfer effect from bondholders to stockholders studied by Masulis (1980, 1983).

Momentum and monthly effect: an anomaly within an anomaly!

This paper evaluates the relation between two well-known anomalies in stock returns, viz, momentum and monthly effect. The monthly effect anomaly refers to the fact that stocks earn positive average returns only during the first half of the month and zero average returns during the second half. In this paper, we show that although the monthly effect anomaly continues to hold for stocks in general (as well as for stocks grouped by size or book-to-market or other criteria), the monthly effect seems to break down for momentum portfolios. This result has implications for implementing a portfolio trading strategy based upon the momentum effect and the monthly effect. We further show that the profitability of momentum portfolios arises from the second half of the month because the monthly effect for winner and loser portfolios is asymmetric. We also examine the risk characteristics of the momentum returns. The risk-adjusted excess return (or alpha) for momentum portfolio was previously reported by other researchers as significant, but is statistically insignificant in recent years.