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BANKRUPTCY AS A CORPORATE risk-management STRATEGY

BANKRUPTCY AS A CORPORATE risk-management STRATEGY. Cynthia L. Krom, PhD, CPA, CFE. “…the reason why firms succeed or fail is perhaps the central question in strategy.” ~ Porter (1991, p.5). What is Chapter 11 bankruptcy?. Bankruptcy Reform Act of 1978 “Reorganization” Assets are frozen

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BANKRUPTCY AS A CORPORATE risk-management STRATEGY

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  1. BANKRUPTCY AS A CORPORATE risk-management STRATEGY Cynthia L. Krom, PhD, CPA, CFE

  2. “…the reason why firms succeed or fail is perhaps the central question in strategy.” ~ Porter (1991, p.5)

  3. What is Chapter 11 bankruptcy? Bankruptcy Reform Act of 1978 • “Reorganization” • Assets are frozen • Temporary relief from collection attempts, foreclosure, and creditor lawsuits • Protect the rights of creditors • On average, a 2 - 3 year process

  4. Incidence of bankruptcy filings Source: American Bankruptcy Institute

  5. “Risk-management” Bankruptcy • “Strategic” bankruptcy – Delaney (1989, 1992) • “Non-financial” bankruptcy – Bankruptcy Yearbook and Almanac (annual since 1980s) • “Creative” bankruptcy – W. Brown (1988) Source: Foster 1986

  6. Risk-management reasons for filing for bankruptcy protection • Asbestos liabilities • Labor relations issues • Regulatory/nuclear/environmental problems • Other litigation & contract problems • Patent lawsuits • Pension disputes • Personal injury lawsuits Source: Bankruptcy Yearbook and Almanac

  7. FIRST LINE OF QUESTIONING ARE THERE FINANCIAL DIFFERENCES BETWEEN RISK-MANAGEMENT BANKRUPTCIES AND FINANCIAL DISTRESS BANKRUPTCIES? ARE THEY DRAWN FROM THE SAME POPULATION?

  8. Financial “health” compared for third and second years prior to Chapter 11 ALTMAN’S Z-SCORE FDB < RMB For the third and second year prior to the year in which bankruptcy filings were made, firms considered to have filed for Chapter 11 protection due to financial distress (FDB) will have Altman’s Z-scores lower than those for firms filing for Chapter 11 protection for risk management reasons (RMB).

  9. Methods to test for financial differences FDB < RMB Altman’s Z-score Altman’s Z categorical 1998 – 2007 Large publicly-traded firms filing for and emerging from Chapter 11 Data from form 10-K from SEC n = 27 RMB n = 199 FDB n = 27 RMB matched n = 27 FDB

  10. Mean Altman’s Z-scores (n=452)

  11. RESULTS: ALTMAN’S Z-SCORE (n=227) THIRD YEAR PRIOR TO CHAP 11 SECOND YEAR PRIOR

  12. RESULTS: ALTMAN’S Z-SCORE CATEGORICAL FDB v. RMB (n = 54) THIRD YEAR PRIOR TO CHAP 11 SECOND YEAR PRIOR

  13. FIRST LINE OF QUESTIONING: FAILED TO SUPPORT THAT FINANCIAL-DISTRESS BANKRUPTCIES AND RISK-MANAGEMENT BANKRUPTCIES ARE DRAWN FROM THE SAME POPULATION WHAT ABOUT RMB COMPARED TO NON-BANKRUPT? MIXED RESULTS

  14. SECOND LINE OF QUESTIONING DO FINANCIAL-DISTRESS BANKRUPTCIES AND RISK-MANAGEMENT BANKRUPTCIES DIFFER IN TURNOVER OF THE TOP MANAGEMENT TEAM AND THE BOARD OF DIRECTORS?

  15. Hypothesized FDB turnover > RMB turnover 27 RMB 27 FDB matched 27 Non-BR matched • Chief Executive Officer • Chief Financial Officer • Chief Operating Officer • Chairperson of the Board • Members of the board Data from 10-K and DEF 14A forms

  16. SECOND LINE OF QUESTIONING • During the 6-year time period FDB FIRMS HAVE MORE TURNOVER THAN RMB FIRMS FOR: • CEO (p < .05) • CFO (p < .01) • COO (p < .01) • Members of the Board (p < .000) • During the 6-year time period RMB FIRMS HAVE MORE TURNOVER THAN NON-BANKRUPT FIRMS FOR: • CEO (p < .05) • CHAIRPERSON OF THE BOARD (p < .05)

  17. First study to support, with financial data, the differentiation of Chapter 11 bankruptcy into FDB and RMB • First study to examine the implications for turnover in the top management team related to FDB and RMB • First study to examine the implications for turnover in the board of directors related to FDB and RMB • One of the first studies in years to look at executive or board turnover as related to bankruptcy in any form CONTRIBUTIONS OF THIS STUDY ALSO: Suggests that bankruptcy modeling may be improved if RMB incidents are segregated from other bankruptcies.

  18. Small sample size limited the power of the statistical tests. • Over time, as more Chapter 11 bankruptcies occur, more data will be available • Use of archival data permits only a coarse-grained approach (annual, not daily) • Inability to access the “insider” information that would illuminate reasons for executive departure, rationale for filing Chapter 11, etc. LIMITATIONS OF THIS STUDY

  19. Could extend beyond the U.S. to other countries with an option similar to Chapter 11 • Could explore relationship between RMB and board composition, board power, insider ownership, etc. • Could explore other signals of RMB, including discretionary accruals, lease ratios, analysts’ ratings • Consider implications of RMB to ratings of corporate social responsibility SUGGESTIONS FOR FUTURE RESEARCH

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