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Financial Distress and Resolution

Paper Session

Sunday, Jan. 6, 2019 10:15 AM - 12:15 PM

Hilton Atlanta, 203
Hosted By: Association of Financial Economists & American Finance Association
  • Chair: Kose John, New York University

Payday before Mayday: CEO Compensation Contracting for Distressed Firms

Mary Ellen Carter
,
Boston College
Edith Hotchkiss
,
Boston College
Mahdi Mohseni
,
Texas A&M University

Abstract

Using detailed information on features of CEO contracts for more than 1,400 US public firms in the period 1998-2016, we examine changes in the structure of CEO compensation contracts when firms become financially distressed. When performance declines, firms face significant changes in liquidity, the need to replace or to retain the incumbent CEO, and the need to align CEO interests with those of shareholders versus creditors, each of which impacts contracting and CEO incentives. We find that distressed firms have lower pay-performance sensitivity if performance is measured against stock or earnings based metrics, but not when measured by cash flow based metrics. Examining the ex-ante compensation contracts, we find that distressed firms increase their overall use of performance metrics, particularly those that are based on cash flows, and set performance targets farther above prior performance. These changes in contracting increase in frequency and magnitude in the years preceding default.

Do Minimum Wage Increases Cause Financial Stress to Small Businesses? Evidence from 15 Million Establishments

Sudheer Chava
,
Georgia Institute of Technology
Alexander Oettl
,
Georgia Institute of Technology
Manpreet Singh
,
Georgia Institute of Technology

Abstract

Do increases in federal minimum wage impact financial health of small businesses? Using inter-temporal variation in whether a state's minimum wage is bound by the federal minimum wage and credit-score data for approximately 15.2 million establishments for the period 1989-2013, we find that increases in federal minimum wage worsen the financial health of small businesses in the affected states. Small, young, labor-intensive, minimum-wage sensitive establishments located in bounded states and businesses located in competitive and low-income areas experience higher financial stress. Increases in minimum wage also lead to lower bank loans, a higher risk of loan default and higher exit rate for affected small businesses. The evidence suggests that some small businesses are unable or unwilling to pass-through costs to customers immediately and consequently experience financial stress. Our results document the costs to the one-size-fits-all nationwide minimum wage and highlight how the increases in minimum wages can have an adverse effect on the financial health of small businesses.

Debt-Equity Simultaneous Holdings and Distress Resolution

Yongqiang Chu
,
University of South Carolina
Ha Diep Nguyen
,
Indiana University
Jun Wang
,
Western University
Wei Wang
,
Queen's University
Wenyu Wang
,
Indiana University

Abstract

We study the effect of financial institutions’ simultaneous holdings of loans and equity; bonds and equity; loans and bonds; and loans, bonds, and equity on the resolution outcome of financially distressed firms. Our results show that simultaneous holdings of debt (loans or bonds) and equity are associated with a higher likelihood of out-of-court restructuring versus bankruptcy. Our identification relies on instrumental regressions and using the merger of financial institutions as a source of exogenous shock to the formation of simultaneous holdings. We further show that the effect of simultaneous holdings on the probability of out-of-court restructuring is stronger when these holders have a larger equity stake in the game and when the expected bankruptcy costs are higher. The combined empirical evidence suggests that simultaneous holdings improve the incentive alignment of debt holders and equity holders to facilitate a cost-effective workout.

Learning by Doing: Judge Experience and Bankruptcy Outcomes

Benjamin Iverson
,
Brigham Young University
Joshua Madsen
,
University of Minnesota
Wei Wang
,
Queen's University
Qiping Xu
,
University of Notre Dame

Abstract

Exploiting the within-district random assignment of large corporate Chapter 11 filings, we estimate the costs of inexperience for bankruptcy judges. Inexperienced judges rule slower from the bench, and their cases spend more time in bankruptcy. Firms with inexperienced judges are less likely to reorganize and have lower debt recovery rates. The learning curve is approximately four years, but exposure to more corporate cases and a greater diversity of businesses accelerates judges' learning. The costs of inexperience are higher when courts are busy. Judges' general skill and personal attributes do not consistently explain case outcomes.
Discussant(s)
Stacey Jacobsen
,
Southern Methodist University
Ashwini Agrawal
,
London School of Economics
Katherine Waldock
,
Georgetown University
Tom Chang
,
University of Southern California
JEL Classifications
  • G3 - Corporate Finance and Governance
  • K2 - Regulation and Business Law