Cost of Bankruptcy

3 Key excerpts on "Cost of Bankruptcy"

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  eBook - ePub

  Handbook of Law and Economics

  • A. Mitchell Polinsky, Steven Shavell(Authors)
  • 2007(Publication Date)
  • North Holland

    (Publisher)

  31

  4.1 Bankruptcy costs

  An ideal measure of the costs of bankruptcy would cover both direct and indirect costs. Direct costs include the legal and administrative costs of bankruptcy, while indirect costs include all the costs of bankruptcy-induced disruptions, including asset disappearance, loss of key employees, and investment opportunities foregone because managers’ time is spent on the bankruptcy. Most studies measure only the direct costs of bankruptcy, because bankrupt corporations must report these costs to the bankruptcy court. Weiss’ (1990) study of 37 corporate bankruptcies during the early 1980’s found that the direct costs of bankruptcy averaged 3.1% of the combined value of debt plus equity. Other studies by have found similar results (see Ang, Chua, and McConnell, 1982 ).

  Indirect bankruptcy costs are more difficult to measure, but are likely to be much greater than direct bankruptcy costs. White (1983) solved for upper bound expressions on indirect bankruptcy costs, using a coalition model of the bankruptcy decision. Her results suggest that the indirect costs of bankruptcy may be as high as twenty times the direct costs of bankruptcy.

  Other studies provide indirect evidence suggesting that bankruptcy is very disruptive. Gilson (1990) and Gilson and Vetsuypens (1994) found that the turnover rates of top executives and directors were much higher for large corporations in Chapter 11 than for those not in bankruptcy. Carapeto (2000) found that when a large corporation in Chapter 11 offers multiple reorganization plans to creditors, the total amount offered declines by 14% between the first and the last plan. This implies that the marginal costs of remaining in bankruptcy longer increase quickly. Hotchkiss (1995)

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  eBook - ePub

  Solomon's Knot

  How Law Can End the Poverty of Nations

  • Robert D. Cooter, Hans-Bernd Schäfer(Authors)
  • 2011(Publication Date)
  • Princeton University Press

    (Publisher)

  Chapter 6 provided the example of Brazil’s legal obstacles to repossessing land and dwellings from defaulting homeowners, which sharply reduces the supply of mortgages. In general, overly generous legal treatment of current debtors reduces credit for future borrowers, which reduces investment and stifles growth.

  Table 10.3 Average Cost of Insolvency Proceedings as a Percentage of the Estate

  Source: World Bank, Doing Business (Washington, DC: World Bank, 2010), stat. Appendix (cost as % of estate in parentheses).

  Some economists try to trace prodebtor laws back to the origins of private law. A study ranked bankruptcy laws in different countries, compared them according to their legal origins, and concluded that countries with a French civil law tradition are relatively prodebtor, whereas countries with a British common law tradition are relatively procreditor.24 If this explanation is correct, then developing countries with bankruptcy laws modeled on Britain have a distinct advantage over those modeled on France.

  Another study finds that powerful judges raise the cost of insolvency proceedings. In some countries, the law assigns all power to the judge—the court appoints and replaces the bankruptcy administrator without restrictions, the trustee reports exclusively to the court and not to the creditors, and the court alone can decide on a plan for restructuring the company. In other countries, the stakeholders have more say. Data suggests that the average cost of insolvency proceedings correlates positively with the power of courts over the bankruptcy process. Conversely, the average cost of insolvency proceedings correlates negatively with the power of stakeholders over the bankruptcy process. The facts suggest (but do not prove) that judges with much power over the bankruptcy process increase its costs.25

  Politics of Bankruptcy

  Politics intrudes into bankruptcy proceedings of private firms in two distinct ways. First, politicians sometimes use bankruptcy procedures to expropriate firms. The most notorious example involved Russia’s largest private oil company, Yukos. Like many natural resource exporters in Russia during the 1990s, Yukos engaged in various practices of doubtful legality. The state eventually charged Yukos with tax evasion, which reduced the company to near bankruptcy and depressed the price of it stock, and then the state bought it. The state also charged its biggest shareholder and chief executive, Michail Khodorkhovsky, with fraud and corruption. He was convicted and sentenced to eight years in prison. Khodorkhovsky was an outspoken opponent of Russian President Putin. Was the state’s deepest motive to get a criminal out of business or to punish the president’s political opponents and to transfer their wealth to his friends? Experts disagree.

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  eBook - ePub

  Doing Corporate Business in Russia

  From Civil Theory to Practice

  • Anna Vlasova, Natalia Udalova, Anna S. Vlasova, Natalia M. Udalova(Authors)
  • 2017(Publication Date)
  • Routledge

    (Publisher)

  8

  BANKRUPTCY OF A CORPORATE BUSINESS ENTITY

  8.1 Bankruptcy grounds

  Bankruptcy regulation: main sources . Bankruptcy is a complicated and extremely important procedure in contemporary entrepreneurship. It is designed to achieve different goals, which depend on the phase of the bankruptcy procedure that is underway. First and foremost, bankruptcy aims at restoring the creditworthiness of a legal entity and normalizing its operations. However, when this is impossible, bankruptcy sets new targets: maximum extinguishment of the creditors’ claims and liquidation of the trouble-making entity.

  As it was noted in Resolution of the Constitutional Court No. 12-P of December 19, 2005, the institute of bankruptcy shall be one of the means aimed at protecting both private and public interests.

  The private interest in bankruptcy may be considered from the bankrupt entity’s point of view, most likely as being to restore the business’s creditworthiness, and from the point of view of the creditor, to which it is most important to receive all the debts payable to it.

  Regarding public interest, it is necessary to keep in mind that bankruptcy procedures have a public legal nature—they imply coercion of a minority of creditors by their majority; therefore, due to the impossibility to otherwise work out a common opinion, the parties’ will shall be shaped according to some other principles, different from those of litigious proceedings. Given the different, often quite opposite, interests of persons involved in a bankruptcy case, the legislator is to guarantee them a balance of their rights and legal interests, which, in fact, is exactly the purpose of the institute of bankruptcy from a public law standpoint.

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