Recent Bankruptcy Business-Related Articles of Interest Available for Downloading from SSRN

The following bankruptcy business-related papers, arranged by abstract ID number, can be downloaded from the Social Science Research Network:

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Stern Stewart & Co.'s Bennett Stewart: "The Real Reasons Enron Failed" (Abstract ID: 943547)

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Arizona State University's Dahlia Robinson: "Tax Service Fees and Auditor Independence: Evidence from Going-Concern Opinions Prior to Bankruptcy Filings" (Abstract ID: 946418)

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Univ. of Bocconi's Pietro Garibaldi: "Hiring Freeze and Bankruptcy in Unemployment Dynamics"  (Abstract ID:  944869)

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Federal Reserve Board's Beth Anne Wilson, Daniel M. Covitz, and Song Han: "Are Longer Bankruptcies Really More Costly?" (Abstract ID: 943776)

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The College of Management - School of Law's Omer Tene: "Revisiting the Creditors' Bargain: The Entitlement to the Going-Concern Surplus in Corporate Bankruptcy Reorganizations" (Abstract ID: 943066

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Trinity University's Barry T. Hirsch: "Wage Determination in the U.S. Airline Industry: Union Power under Product Market Constraints" (Abstract ID:  941127)

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London Business School's Viral V. Acharya, Univ. of Michigan's Sreedhar T. Bharath, and National Univ. of Singapore's Anand Srinivasan: "Does Industry-wide Distress Affect Defaulted Firms? Evidence from Creditor Recoveries" (Abstract ID:  940630

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Yale Law School's Alan Schwartz: "Valuation of Collateral" (Abstract ID:  938709)

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Adam Levitin: "Finding Nemo: Rediscovering the Virtues of Negotiability in the Wake of Enron" (Abstract ID: 936253)

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Virginia Polytechnic University's John C. Easterwood and Vanderbilt University's Charu G. Raheja: "CEOs vs. Directors: Who Calls the Shots When Firms Underperform?" (Abstract ID: 931037)

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Chapman Univ. School of Law's Daniel B. Bogart: "Unexpected Gifts of Chapter 11: The breach of a Director's Duty of Loyalty Following Plan Confirmation and the Postconfirmation Jurisdiction of Bankruptcy Courts" (Abstract ID: 930161)

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Indiana University's Derek Oler and Univ. of Kansas's Kevin R. Smith: "The Characteristics and Fate of 'Take Me Over' Firms" (Abstract ID: 930389)

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Abstracts for each of these papers follows:

Bennett Stewart, "The Real Reasons Enron Failed" (Abstract ID: 943547):

In desperate attempts to keep up with aggressive earnings targets, Enron's managers became so indiscriminate in committing the firm's capital that, in 1999, the international energy division presented Skilling with a plan that contemplated earning just $100 million in profit on a capital base of $7 billion. With that kind of performance which amounts to a loss of several hundred million in terms of economic profits the CFO faced considerable pressure to use deceptive tactics to put off the day of reckoning. The real Enron story may thus be more than the morality play told in press accounts. A major part of the blame must be assigned to the design of the company's performance measures and internal controls. This article argues that the popular accounts may confuse causes and consequences and suggests that the seeds of Enron`s demise were sown years before criminal behavior took root. The more fundamental causes appear to have been matters of organizational design in particular, bonus plans that paid managers to increase reported earnings; the use of mark-to-market accounting, with the blessing of the SEC, in generating those earnings; and CEO Skilling's decision to permit CFO Fastow to make finance a profit centrally of which happened five to ten years before Enron's bankruptcy filing. Why did Enron fail? Was it the criminality of key corporate executives, and their resort to deceptive bookkeeping and off-balance sheet financing, as the popular accounts suggest? This article argues that the popular accounts may confuse causes and consequences and suggests that the seeds of Enron's demise were sown years before criminal behavior took root. The more fundamental causes appear to have been matters of organizational designing particular, bonus plans that paid managers to increase reported earnings; the use of mark-to-market accounting, with the blessing of the SEC, in generating those earnings; and CEO Skilling's decision to permit CFO Fastow to make finance a profit centerall of which happened five to ten years before Enron's bankruptcy filing. In desperate attempts to keep up with aggressive earnings targets, Enron's managers became so indiscriminate in committing the firm's capital that, in 1999, the international energy division presented Skilling with a plan that contemplated earning just $100 million in profit on a capital base of $7 billion. With that kind of performance which amounts to a loss of several hundred million in terms of economic profits the CFO faced considerable pressure to use deceptive tactics to put off the day of reckoning. The real Enron story may thus be more than the morality play told in press accounts. A major part of the blame must be assigned to the design of the company's performance measures and internal controls.

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Dahlia Robinson, "Tax Service Fees and Auditor Independence: Evidence from Going-Concern Opinions Prior to Bankruptcy Filings" (Abstract ID: 946418):

This study examines the issue of auditor independence and auditor-provided tax service fees by focusing on auditors' going concern opinions among a sample of bankruptcy filing firms. The evidence from the bankruptcy setting is particularly salient to the debate on auditor independence and non-audit services because the bankruptcies of several large corporations such as Enron brought the issue to center stage and motivated several provisions of the Sarbanes-Oxley Act (SOX) of 2002. More recently, auditors' provision of tax service to their audit clients has been the focus of new rules by the Public Company Accounting Oversight Board (PCAOB). However, given that the review of the client's tax returns and reserves require substantial knowledge about the audit client, it is possible that auditor-provided tax services may enhance audit quality through information spillover. Contrary to concerns about diminished auditor independence, but consistent with improved audit quality, the study documents a significant positive correlation between the level of tax services fees and the likelihood that the auditor will correctly issue a going concern qualified opinion prior to the bankruptcy filing. The result is robust to controls for unexpected fees and endogeneity among the fee variables. One implication of this result is that restricting tax services by auditors of poorly performing firms may diminish the quality of auditors' reporting decisions without leading to an improvement in auditor independence.

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Pietro Garibaldi, "Hiring Freeze and Bankruptcy in Unemployment Dynamics"  (Abstract ID:  944869):

This paper proposes a matching model that distinguishes between job creation by existing firms and job creation by firm entrants. The paper argues that vacancy posting and job destruction on the extensive margin, i.e. from firms that enter and exit the labour market, represents a viable mechanism for understanding the cyclical properties of vacancies and unemployment. The model features both hiring freeze and bankruptcies, where the former represents a sudden shut down of vacancy posting at the firm level with labour downsizing governed by natural turnover. A bankrupt firm, conversely, shut down its vacancies and lay offs its stock of workers. Recent research in macroeconomics has shown that a calibration of the Mortensen and Pissarides matching model account for 10 percent of the cyclical variability of the vacancy unemployment ratio displayed by U.S. data. A calibration of the model that explicitly considers hiring freeze and bankruptcy can account for 20 to 35 percent of the variability displayed by the data.

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Beth Anne Wilson, Daniel M. Covitz, and Song Han, "Are Longer Bankruptcies Really More Costly?" (Abstract ID: 943776):

We test the widely held assumption that longer restructurings are more costly. In contrast to earlier studies, we use instrumental variables to control for the endogeneity of restructuring time and creditor return. Instrumenting proves critical to our finding that creditor recovery rates increase with duration for roughly 1½ years following default, but decrease thereafter. This, and similar results using the likelihood of reentering bankruptcy, suggest that there may be an optimal time in default. Moreover, the default duration of almost half of our sample is well outside the optimal default duration implied by our estimates. We also find that creditors benefit from more experienced judges and from oversight by only one judge. The results have implications for the reform and design of bankruptcy systems.

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Omer Tene: "Revisiting the Creditors' Bargain, The Entitlement to the Going-Concern Surplus in Corporate Bankruptcy Reorganizations" (Abstract ID: 943066): 

Bankruptcy literature is increasingly accepting the continued existence of bankruptcy and secured debt and becoming more interested in analyzing specific features thereof. This article undertakes such a task, analyzing the entitlement to the going-concern surplus (GCS) generated during corporate reorganization proceedings, over and beyond the liquidation value of secured creditors' collateral. The GCS question has failed to receive satisfactory judicial attention despite underlying several bankruptcy decisions of the Supreme Court. In Timbers, the Supreme Court implicitly awarded the GCS to the debtor; in Dewsnup, to a secured creditor; in Rash, apparently, to a secured creditor, subject to a confusing footnote; and in LaSalle, the Court chose to sidestep the issue altogether.

The article suggests protecting secured creditors up to the real liquidation value of their collateral. Chapter 11 is a forum for structured negotiations among investors. Bankruptcy law must protect the value of the participants' entitlements at the outset of the case, but go no further in determining their substantive rights. It must provide a set of procedural provisions that ensure a fair and level platform for multiparty negotiations. Limiting senior creditors' priority to the real liquidation value of their collateral facilitates the distribution of the GCS among participants according to their contribution to the firm's rehabilitation. As long as the standard of protection is known in advance, senior lenders can compensate themselves by adjusting the interest rate and terms of their loans. The participation of all parties in such transactions will secure organizational development and innovative growth, thereby enhancing ex ante efficiencies.

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Barry T. Hirsch, "Wage Determination in the U.S. Airline Industry: Union Power under Product Market Constraints" (Abstract ID:  941127): 

The paper analyzes wages in the U.S. airline industry, focusing on the role of collective bargaining in a changing product market environment. Airline unions have considerable strike threat power, but are constrained by the financial health of carriers. Since airline deregulation, compensation has waxed and waned in response to the industry's economic environment. Airline workers capture sizable rents following good times and provide concessions following lean times. Compensation at legacy carriers has been restructured; it remains to be seen if compensation will continue its long-run movement toward opportunity costs. Evidence from the CPS for 1995-2006 shows that wage premiums for airline industry workers remain, particularly for pilots, with existing premiums almost entirely a union phenomenon. Much of the gap in wage scales between major and mid-size carriers was erased in the mid-2000s concessionary cycle, but these rates remain much higher than rates at regional carriers. Compensation levels at regional carriers may approximate opportunity cost – the compensation necessary to attract and retain qualified employees throughout the industry. Because unions retain bargaining power at the major carriers, wages are likely to head upward as carriers' financial health returns. Such wage levels may or may not be sustainable in the inevitable next downturn.

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Viral V. Acharya, Sreedhar T. Bharath, and Anand Srinivasanm, "Does Industry-wide Distress Affect Defaulted Firms? Evidence from Creditor Recoveries" (Abstract ID:  940630): 

Using data on defaulted firms in the United States over the period 1982 to 1999, we show that creditors of defaulted firms recover significantly lower amounts in present-value terms when the industry of defaulted firms is in distress. We investigate whether this is purely an economic-downturn effect or also a fire-sales effect along the lines of Shleifer and Vishny (1992). We find the fire-sales effect to be also at work: Creditors recover less if the industry is in distress and non-defaulted firms in the industry are illiquid, particularly if the industry is characterized by assets that are specific, that is, not easily redeployable by other industries, and if the debt is collateralized by such specific assets. The interaction effect of industry-level distress and asset-specificity is strongest for senior unsecured creditors, is economically significant, and robust to contract-specific, firm-specific, macroeconomic, and bond-market supply effects. We also document that defaulted firms in distressed industries are more likely to emerge as restructured firms than to be acquired or liquidated, and spend longer in bankruptcy.

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Alan Schwartz, "Valuation of Collateral" (Abstract ID:  938709): 

This short Essay analyzes two Supreme Court cases that considered valuation issues in consumer bankruptcy cases: Associates Commercial Corp. v. Rash, 520 U.S. 953 (1997), and Till v. SCS Credit Corp., 541 U.S. 465 (2004). The Bankruptcy law provides some wage insurance by permitting debtors to discharge debts in bad states of the world, and also provides incentives for borrowers to avoid those states because bankruptcy is costly to persons and discharge may not be complete. The Essay shows that these two cases reach inconsistent results from an insurance and an incentive point of view. Rash chose a valuation standard for collateral whose effect is to reduce the Code's ability to insure, but thereby to increase the borrower's incentive to avoid bankruptcy. Till chose an interest rate standard for discounting to present value the periodic payments that are supposed to equal the collateral's actual value. The effect of the Till standard is to require the individual borrower to purchase more insurance against default than theretofore, and thereby to reduce the borrower's incentive to avoid bankruptcy. The opinions in Till appear to be unaware of these inconsistencies, and the opinions in Rash seem not to understand its effect. Both cases also increased the administrative costs of bankruptcy by creating additional occasions for valuation and interest rate hearings. The Essay concludes by remarking that the Supreme Court's limited competence in the bankruptcy field and its restricted docket suggest that the task of harmonizing bankruptcy law among the circuits actually falls on the circuit courts unaided. These courts thus should be more sensitive to uniformity issues than they have been.

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Adam Levitin, "Finding Nemo: Rediscovering the Virtues of Negotiability in the Wake of Enron" (Abstract ID: 936253):

Creditors have long understood that any claims they submit for repayment in a bankruptcy might be valid, but subject to subordination in the order of payment of the bankruptcy estate's limited funds if the creditor behaved inequitably as the debtor failed. A groundbreaking opinion in Enron's on-going bankruptcy has expanded the practice of equitable subordination far beyond its traditional reach. According to the court, buyers of bankruptcy claims are now subject to subordination, not just for their own conduct, but also for conduct of previous owners of the claims, regardless of whether the conduct related to the claims.

In a world of active bankruptcy claims trading, Enron raises powerful policy questions about the legal rules governing property transfers that affect the doctrinal development of bankruptcy law and the survival of a secondary market that provides important liquidity to other capital markets. This article shows how Enron was erroneous from both doctrinal and policy perspectives and examines the problems Enron has created for several distinct markets.

Enron is a reminder of the continuing value of negotiability in commercial contexts, for if the claims involved had been negotiable, they could not have been subordinated. Thus, this article considers what factors have traditionally determined when the law adopts a negotiability regime for property transfers and whether these factors make sense in today's financial markets. The article argues that in the bankruptcy claims context, the liquidity benefits of negotiability outweigh its costs. Accordingly, the article proposes a federal law of negotiability for bankruptcy claims to protect the liquidity of this vital market..

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John C. Easterwood and Charu G. Raheja, "CEOs vs. Directors: Who Calls the Shots When Firms Underperform?" (Abstract ID: 931037): 

We study the evolution of the board in response to a sudden negative performance shock and highlight the importance of the balance of power between the board and the CEO in determining the changes. We find that board size increases following poor performance, and boards become more independent. Overall, there is a high turnover of directors when firms underperform and director ownership decreases. After firms underperform, the proportion of directors who work as consultants and of directors who are executives in other firms increases, while the proportion of directors in the financial industry, directors who hold multiple board seats, and directors representing large shareholders, decreases. CEO influence, as measured by the likelihood that the original CEO will depart the firm following the underperformance event, is an important factor on the observed board changes. Influential CEOs are associated with smaller increases in board independence and less director turnover. Changes in the percentage of directors who are executives in other firms and directors who are representatives of large shareholders are also negatively related to CEO influence. Together, these results suggest that influential CEOs are able to maintain their influence in firms following an underperformance event. The CEO influence and board changes are not related to subsequent changes in firm performance and the likelihood that firms will experience a financial restructuring event. We conclude that firms adjust their boards based on their own specific managerial and firm requirements.

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Daniel B. Bogart, "Unexpected Gifts of Chapter 11: The Breach of a Director's Duty of Loyalty Following Plan Confirmation and the Postconfirmation Jurisdiction of Bankruptcy Courts" (Abstract ID: 930161):

This article addresses the intersection of two aspects of chapter 11 jurisprudence: the fiduciary duties of directors and officers of the debtor and the post confirmation jurisdiction of bankruptcy courts. The article suggests that the normal application of fiduciary duties to confirmed debtors creates particular opportunities for directors and officers to act in a disloyal manner. The article examines two cases in particular. These include Bernstein v. Donaldson (In re Insulfoams, Inc.) and Cumberland Farms, Inc. v. Hasenotes (In re Cumberland Farms, Inc.) Traditionally, courts and commentators suggest that normal state fiduciary standards govern directors post confirmation. The article argues, however, that in certain scenarios directors may use the chapter 11 process to set the stage for disloyal behavior following confirmation of the plan of reorganization. In these instances, a federal, trustee-based standard of loyalty should apply to acts taken by directors post confirmation. The article also evaluates the various provisions of the Code that might permit a bankruptcy court to exercise post confirmation jurisdiction. The author notes that in his 2003 article, Resisting the Expansion of Bankruptcy Court Power, 35 Arizona St. L. J. 793 (2003), the author recanted his views of Section 105 of the Code, and acknowledged that this section is not a basis for post confirmation jurisdiction.

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Derek Oler and Kevin R. Smith, "The Characteristics and Fate of 'Take Me Over' Firms" (Abstract ID: 930389): 

 We investigate firms that publicly advertise a desire to be taken over (TMO firms). TMO firms appear to be motivated by a desire to avoid bankruptcy, and show evidence of high debt levels, fundamental underperformance, and aggressive accounting. While the TMO announcement indicates a greater likelihood of becoming a target firm, it also signals severely negative future returns. Future returns are negative regardless of whether the firm continues trading, is taken over, or is delisted; the worst-performing TMO firms are those that have the highest degree of "bloat" in their balance sheets at the time of the TMO announcement.

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© Steve Jakubowski 2007