Bankruptcy as a deliberate strategy: Theoretical considerations and empirical evidence

Abstract

7Bankruptcy and bankruptcy reorganizations have been identiJied as remedies for financial distress, but there is little agreement on their value to firms, managers, and the general economy. This paper provides a brief review of proposed bankruptcy strategies and some alternative views about their costs and benefits followed by an empirical study of the outcomes of 73 bankruptcies and subsequent reorganization efforts. The evidence suggests that there are few successful reorganizations, bankruptcy is a costly response to financial distress, and managerial choice in bankrupt firms is highly constrained by forces external to the firm. The diversity of stakeholder interests limits the value of global judgements about success or failure of bankruptcy strategies. Firm size dominates all other factors in predicting success in completing the reorganization process. Delayed filings primarily reflect failed efforts to avoid bankruptcy, not deliberate strategies. Reasons for the use of bankruptcy in spite of its high costs are discussed.Over the past decade, since the implementation of the Bankruptcy Reform Act of 1978, there has been a growing perception that deliberate bankruptcy can be used by managers as an effective strategy for dealing with financial distress. In a recent article in this Journal by Flynn and Farid (1991: 73) state 'Chapter XI (sic) can be used as a strategic alternative to realign the organization with its strategic competencies with a higher probability of reemerging from bankruptcy as a revitalized organization.' We believe that this view is Key words: Bankruptcy, business failure, financial distress, reorganization oversimplistic and overoptimistic. In this paper we will present evidence that bankruptcy reorganizations are not a simple matter, and that the probability of successful outcomes is low. A critical difference between Flynn and Farid's view and ours revolves around the issue of managerial control. The complexity of the bank-' The article by Flynn and Farid (1991) also suffers from their use of titles and provisions of the old Bankruptcy Act, which was replaced by a new Bankruptcy Code under the Bankruptcy Reform Act of 1978. A standard source for legal information on the Bankruptcy Code and Rules is the Collier Bankruptcy Manual (King, 1981). A good source for financial and accounting information is Bankruptcy and Insolvency Accounting, 3rd ed. (Newton, 1985 and Supplements).

Corporate distress and turnaround: integrating the literature and directing future research

“…Over 40% of firms that file for Chapter 11 experience operating losses in the 3 years following bankruptcy, with one-third reentering bankruptcy or private debt restructuring (Hotchkiss 1995). This yields less than 10% successful turnaround cases (Moulton and Thomas 1993). The fact that a majority of firms undertaking operational restructuring efforts require further restructuring indicates a potential bias toward unprofitable firms' continuation (Acharya et al 2007;Hotchkiss 1995;Routledge and Gadenne 2000).…”

“…Regarding the retrenchment phase's timing, scholars resort to the organizational inertia concept as part of the threat-rigidity theory (Wicks 2001), as retrenching actions should be initiated as soon as possible to ensure short-term stabilization (Jansen 2004;Moulton and Thomas 1993;Sheppard 1994). Large firms are especially disposed to organizational rigidity in the face of distress, as pre-distress inertia is already high (Audia and Greve 2006;Rosenblatt et al 1993).…”

“…The most commonly included context variable is firm size, which some scholars claim dominates all other turnaround likelihood factors (Greve 2011;Moulton and Thomas 1993;Robbins and Pearce 1993). The direction of this causality seems unambiguous, with a positive correlation between firm size and survival chances Ahmadjian and Robinson 2001;Kato 2010;Ramanujam 1984;Stoeberl et al 1998).…”

“…Operational restructuring is often especially constrained by legitimacy problems (Ahmadjian and Robinson 2001;Lynn and Rao 1995). Hence, Moulton and Thomas (1993) conclude that turnaround activities are highly constrained by forces external to the organization. Dawley et al (2002) state that these macroeconomic constraints can even yield default.…”

Organizational Decline Research Review: Challenges and Issues for a Future Research Agenda

“…This factor is also composed of prescriptive works such as contingency theory for turnaround (Hofer, 1980), hierarchy of change and structural growth (Katz & Kahn, 1966) and a chapter on competitive strategy in declining industries from Michael Porter's book (Porter, 1980). The first factor of the second period, covering 1991 to 2002, was TMT in organizational decline, made up of studies on the TMT in decline situations (Altman & Hotchkiss, 1983;Gilson, 1989) and especially in the case of bankruptcy, such as studies on TMT as a scapegoat (Boeker, 1992;, the deterioration of the TMT (Hambrick & D'Aveni, 1992;Moulton & Thomas, 1993), and the stigma of TMT (Sutton & Callahan, 1987). This factor also included studies on decision making in situations of risk (Singh, 1986), threat-rigidity effects (Staw et al, 1981) and the aforementioned resource dependence theory (Pfeffer & Salancick, 1978).…”