Abstract
The main purpose of this paper is to investigate how banks resolve firms’ financial distress in Japan. Our results show that distressed firms that have more unsecured bank debt are more likely to restructure debt successfully out of court. Second, private debt restructuring is conducted during the year in which a financially distressed firm would be compelled to report negative net worth because of substantial accounting losses if no debt restructuring plans were implemented. Third, firms that are already in a negative net worth situation are more likely to receive debt forgiveness and/or debt-for-equity swaps. Finally, both the 1-year-lagged total liabilities-to-assets ratio and accounting losses are positively related to the private workout level. These results suggest that banks resolve firms’ financial distress in shareholders’ and creditors’ interests. We argue that, along with bankruptcy laws, the stock exchange rules and the fact that banks are allowed to hold shares in these firms affect the resolution of firms’ financial distress.
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Notes
Jostarndt and Sautner (2007) stated that bankruptcy costs are lower for private workouts than for formal bankruptcy proceedings in Germany, where house banks maintain relationships with borrowing companies.
The Japanese Anti-Monopoly Act limits banks’ equity holdings of non-financial firms to 5% of all outstanding shares. Since 2001, this rule has not applied when distressed firms conduct debt-for-equity swaps by issuing preferred shares.
Hotchkiss (1995) suggested that US Chapter 11 favors management by allowing them to make inefficient, self-serving decisions or allowing less able managers to retain their positions.
Helwege and Packer (2003) pointed out that Japanese bankruptcy laws are pro-creditor, even after 2000.
In contrast, automatic stay under the US Chapter 11 prevents creditors’ holdout problems and creates benefits for shareholders. Kim and Kwok (2009) find evidence that managerial ownership is positively related to the likelihood that a US distressed firm voluntarily chooses Chapter 11 as a resolution mode when there are conflicts of interests between shareholders and creditors.
Using German data, Jostarndt and Sautner (2007) found that distressed companies that borrow more using loans that are at least partially collateralized are less likely to restructure debt out of court. Chatterjee et al. (1996) found that firms that issued more bank debt are less likely to restructure their debt out of court and argued that bank debt is usually secured, so banks have an incentive to resolve firms’ financial distress through formal bankruptcy.
Investigating 1,472 financially distressed companies in countries of eastern Asia (Indonesia, Korea, Malaysia, the Philippines; Thailand), Claessens et al. (2003) found that firms that are owned by a bank or by a business group that also owns a bank are less likely to file for in-court bankruptcy.
Also during that term, the government (Financial Service Agency) forced banks to write off nonperforming loans, rather than accumulating provisions.
As the US data also shows, some distressed Japanese firms become financially distressed again and file for in-court bankruptcy after receiving private workouts (Asquith et al. 1994); this result is attributable in part to the high TLAR after the private workout.
Banks could also provide workouts of other types (e.g., reduction in interest) when a sample firm has low interest coverage but the TLAR is much lower than 100%.
In contrast, Claessens et al. (2003) found no significant relationship between firm size and the likelihood that a distressed firm files for in-court bankruptcy.
We define a main bank as the largest bank shareholder of a firm because we focus on how banks’ equity stakes influence their choice of resolution for distressed firms.
Consistent with this view, Inoue et al. (2008) found that out-of-court debt restructurings that are mediated by third parties (such as external sponsors or bank supervisors) have more favorable stock price responses than do private workouts led by main banks.
We do not find a significant coefficient on TLAR even when we delete the TLAR > 1 dummy from the independent variable.
For the workout and bankrupt samples as a whole, the correlation coefficient between the natural logarithm of assets and the natural logarithm of annual stock trading volume (main bank ownership) is 0.48 (0.74).
This view suggests that distressed firms will suffer from serious reduction in their value if their main banks cannot provide workouts due to their declined financial healthiness. Consistent with this argument, Tetsuya (2005) shows evidence that bank merger announcements have a positive impact on stock prices of financially distressed Japanese companies.
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Acknowledgments
Earlier versions of this paper were presented at the Global Conference on Business and Finance, Southwestern Finance Association, Nippon Finance Association, Japanese Association of Applied Economics, and finance seminars held at Hitotsubashi University, Kyushu University, Nanzan University, and Seinan Gakuin University. We thank Marc Bremer, Kotaro Inoue, Joseph P. Ogden, Peng Xu, and Noriyuki Yanagawa for their helpful comments and advice. This research is supported financially by the JSPS Grant-in-Aid for Scientific Research and the Zengin Foundation.
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Goto, N., Uchida, K. How do banks resolve firms’ financial distress? Evidence from Japan. Rev Quant Finan Acc 38, 455–478 (2012). https://doi.org/10.1007/s11156-011-0235-2
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DOI: https://doi.org/10.1007/s11156-011-0235-2