Systemic Financial Distress and Auction-Based Bankruptcy Reorganization

Most bankruptcy procedures try to reorganize a financially-distressed firm's debts to a serviceable level through negotiations overseen by courts. Markets are an alternative to such negotiations. This paper develops a market-based approach that is appropriate if claimants are severely cash-cons...

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Main Authors:	Hausch, Donald B., Ramachandran, S.
Format:	Journal Article
Language:	EN
Published:	2012
Subjects:	Financing Policy Financial Risk and Risk Management Capital and Ownership Structure G320 Bankruptcy Liquidation G330 Corporation and Securities Law K220 Economic Development: Financial Markets Saving and Capital Investment Corporate Finance and Governance O160 Formal and Informal Sectors Shadow Economy Institutional Arrangements O170
Online Access:	http://hdl.handle.net/10986/5825

id	okr-10986-5825
recordtype	oai_dc
spelling	okr-10986-58252021-04-23T14:02:23Z Systemic Financial Distress and Auction-Based Bankruptcy Reorganization Hausch, Donald B. Ramachandran, S. Financing Policy Financial Risk and Risk Management Capital and Ownership Structure G320 Bankruptcy Liquidation G330 Corporation and Securities Law K220 Economic Development: Financial Markets Saving and Capital Investment Corporate Finance and Governance O160 Formal and Informal Sectors Shadow Economy Institutional Arrangements O170 Most bankruptcy procedures try to reorganize a financially-distressed firm's debts to a serviceable level through negotiations overseen by courts. Markets are an alternative to such negotiations. This paper develops a market-based approach that is appropriate if claimants are severely cash-constrained and there is merit in having existing owners-managers remain in control. This approach was developed in response to the 1997 Asian Crisis, where the sheer numbers of over-indebted firms, creditors with poor incentives, and inexperienced courts stymied negotiated resolution. The scheme, however, can be applied to other crisis settings that exhibit particular characteristics. One such setting could be the resolution of external sovereign debts, a situation where creditors obviously cannot take possession of a country. The scheme arranges creditors in a queue to be serviced in sequence from the firm's operating cash flows. Creditors bid for their position in this queue, and those accepting a greater proportionate reduction in the face value of their claims are placed ahead of the others. Any existing hierarchy of claims is honored by having claimants bid for their positions within the relevant segment of the queue. No one in the queue (including owners who are last) is paid anything until the (reduced) debts of the first in line are fully discharged using the firm's operating cash surpluses. The queue then moves up and the next claimant in line is serviced. The paper shows that, in equilibrium, the aggregate debts of the firm are reduced enough to provide a positive expected residual return to the owner-managers, which improves their incentives to efficiently operate the firm and can result in an outcome that is Pareto superior to other bankruptcy procedures. We discuss the efficiency properties of this scheme and its appropriateness to situations of systemic financial distress. 2012-03-30T07:34:44Z 2012-03-30T07:34:44Z 2009 Journal Article International Review of Economics and Finance 10590560 http://hdl.handle.net/10986/5825 EN http://creativecommons.org/licenses/by-nc-nd/3.0/igo World Bank Journal Article
repository_type	Digital Repository
institution_category	Foreign Institution
institution	Digital Repositories
building	World Bank Open Knowledge Repository
collection	World Bank
language	EN
topic	Financing Policy Financial Risk and Risk Management Capital and Ownership Structure G320 Bankruptcy Liquidation G330 Corporation and Securities Law K220 Economic Development: Financial Markets Saving and Capital Investment Corporate Finance and Governance O160 Formal and Informal Sectors Shadow Economy Institutional Arrangements O170
spellingShingle	Financing Policy Financial Risk and Risk Management Capital and Ownership Structure G320 Bankruptcy Liquidation G330 Corporation and Securities Law K220 Economic Development: Financial Markets Saving and Capital Investment Corporate Finance and Governance O160 Formal and Informal Sectors Shadow Economy Institutional Arrangements O170 Hausch, Donald B. Ramachandran, S. Systemic Financial Distress and Auction-Based Bankruptcy Reorganization
relation	http://creativecommons.org/licenses/by-nc-nd/3.0/igo
description	Most bankruptcy procedures try to reorganize a financially-distressed firm's debts to a serviceable level through negotiations overseen by courts. Markets are an alternative to such negotiations. This paper develops a market-based approach that is appropriate if claimants are severely cash-constrained and there is merit in having existing owners-managers remain in control. This approach was developed in response to the 1997 Asian Crisis, where the sheer numbers of over-indebted firms, creditors with poor incentives, and inexperienced courts stymied negotiated resolution. The scheme, however, can be applied to other crisis settings that exhibit particular characteristics. One such setting could be the resolution of external sovereign debts, a situation where creditors obviously cannot take possession of a country. The scheme arranges creditors in a queue to be serviced in sequence from the firm's operating cash flows. Creditors bid for their position in this queue, and those accepting a greater proportionate reduction in the face value of their claims are placed ahead of the others. Any existing hierarchy of claims is honored by having claimants bid for their positions within the relevant segment of the queue. No one in the queue (including owners who are last) is paid anything until the (reduced) debts of the first in line are fully discharged using the firm's operating cash surpluses. The queue then moves up and the next claimant in line is serviced. The paper shows that, in equilibrium, the aggregate debts of the firm are reduced enough to provide a positive expected residual return to the owner-managers, which improves their incentives to efficiently operate the firm and can result in an outcome that is Pareto superior to other bankruptcy procedures. We discuss the efficiency properties of this scheme and its appropriateness to situations of systemic financial distress.
format	Journal Article
author	Hausch, Donald B. Ramachandran, S.
author_facet	Hausch, Donald B. Ramachandran, S.
author_sort	Hausch, Donald B.
title	Systemic Financial Distress and Auction-Based Bankruptcy Reorganization
title_short	Systemic Financial Distress and Auction-Based Bankruptcy Reorganization
title_full	Systemic Financial Distress and Auction-Based Bankruptcy Reorganization
title_fullStr	Systemic Financial Distress and Auction-Based Bankruptcy Reorganization
title_full_unstemmed	Systemic Financial Distress and Auction-Based Bankruptcy Reorganization
title_sort	systemic financial distress and auction-based bankruptcy reorganization
publishDate	2012
url	http://hdl.handle.net/10986/5825
_version_	1764396448132104192

Systemic Financial Distress and Auction-Based Bankruptcy Reorganization

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