GDP, M&A, EBITDA, P/E, NASDAQ, Econo-thread Part 13

[HershOstropoler]

That's ok in principle, but sometimes avoiding liquidation of the enterprise means that an uncompetitive allocation of capital survives, creates overcapacity, and goes into bancruptcy again. Steel and I think airlines would be examples. The "bankruptcy risk is incorporated in the interest rate charged", probably, but they can restart with much less debt...

Are there any plans for a Ford bailout ?

[TCO]

Originally posted by HershOstropoler
That's ok in principle, but sometimes avoiding liquidation of the enterprise means that an uncompetitive allocation of capital survives, creates overcapacity, and goes into bancruptcy again. Steel and I think airlines would be examples..

Sure so the banks have to make a decision, is the value of the company higher as a going concern (ignoring previous financing...that is a sunk cost) or is it more valuable to liquidate the company. For instance if the company just made some bad investments but the core of it is a cash-producing machine. Or if there is a strong brand. Or very good and complex operations (that will be disrupted by a liquidation). Of course that is a judgement call. They have to decide that taking equity in the company and keeping it around (or selling to a finaincial buyer) is worth 40 cents versus the 30 cents they get for the airplanes...errr...I mean assets . And of course, even if that value IS 40 cents, that represents an estimate. With a fair amount of uncertainty. So it shouldn't surprise us to see the thing go into bankruptcy again. Nothing lasts forever. Including reorganized companies.

Regarding "overcapacity" etc.: Obviously the creditors have to make decisions based on their own interests. Not "industry structure". Of course, sometimes a bankruptcy can make it easier for industries to get the anti-trust guys to let them do what they want to do. create oligopolies.

Of course the management and workers and politicians have an incentive to keep the company around even if liquidation is better for the banks.

The "bankruptcy risk is incorporated in the interest rate charged", probably, but they can restart with much less debt...

Not sure what your point is. Mine was the very simple one that the bankers take default into account as a risk when they set rates. We shouldn't get too excited by some bankruptcies of airlines and resultant haircuts for GE Capitol and Pratt and Whitney and such.

Are there any plans for a Ford bailout ?

Nothing I've heard. But one could see how it could be a political issue. And Bush has already caved similarly with the steel industry. There is also the precedent of Chrysler. Still it wouldn't surprise me to just see it allowed to go though bankruptcy. I'm not an expert in the politics here.

[TCO]

Not sure how the extra cute smilies snuck in. They ARE little devils.

[HershOstropoler]

The issue with your first point is how much creditors control the outcome. I do not know the specifics of US law, but at least the judge has a good deal of discretion. I don't know what role the management plays.

"Not sure what your point is."

If you write off 90 % of the debt, is a higher lending cost enough to outweigh that advantage ? Bancrupcy can be a competition advantage.

[HershOstropoler]

Originally posted by GP
Not sure how the extra cute smilies snuck in. They ARE little devils.

You've made it look like I was flirting with you.

[TCO]

There is a very good section in the Brealey and Myers on bankruptcy law and practice. Obviously this stuff has implicit effects on the financing structures that companies use, the interests rates, etc. If the bankruptcy law differs from the ideal it will effect the cost of capital. For instance, equity-holders have an incentive to run a company in the ground. If their stock value is negative, they have nothing to lose by keeping the company going...and to do very risky experiments. This is why there are pages and pages of legalese covering debt agreements. It's also why bankruptcy courts tilt a little more towards creditors and against management/shareholders.

[TCO]

Originally posted by HershOstropoler
The issue with your first point is how much creditors control the outcome. I do not know the specifics of US law, but at least the judge has a good deal of discretion. I don't know what role the management plays.

The judge/court controls it. I address this a little in another post.

If you write off 90 % of the debt, is a higher lending cost enough to outweigh that advantage ?

I'm still not getting it. I was referring to the interest rate with first debt load. Any future debt will be at a different rate reflecting the new capital structure. The old write-off is a sunk cost. Of course, if the management is profligate and is still there, new lenders will charge a higher rate because of the higher risk of future defaults. But if thats not the case and the overall business is sound, new lenders will be willing to come in without a huge premium.

Bancrupcy can be a competition advantage.

huh? And so? Really puzzled. Please break it down for me. Is this anything wrong? Bankruptcy is just an adjustment of the financing structure (assuming the entity stays around.) Why shouldn't companies do that? Or creditors do that, if it is value-maximizing?

[TCO]

Originally posted by GP
There is a very good section in the Brealey and Myers on bankruptcy law and practice. Obviously this stuff has implicit effects on the financing structures that companies use, the interests rates, etc. If the bankruptcy law differs from the ideal it will effect the cost of capital. For instance, equity-holders have an incentive to run a company in the ground. If their stock value is negative, they have nothing to lose by keeping the company going...and to do very risky experiments. This is why there are pages and pages of legalese covering debt agreements. It's also why bankruptcy courts tilt a little more towards creditors and against management/shareholders.

(Extending remarks)

Aaron Brown makes the point that bankers can also have an incentive to screw equity-holders. That they may want to tip the company into bankruptcy at the first hint of danger. (Kinda complicated...but the lend money with an implicit risk profile...once lended, they have an incentive to revise that risk profile.) So this is another reason for having all the covenants so long and legaleseish.

He also makes the point that managment is assumed to act in the interests of equity-holders and that courts act with this assumption. But that may not always be the case. Management can in effect cut a deal with bankers to steal the company. So he argues for bankruptcy courts to take this more into consideration.

[Imran Siddiqui]

You've made it look like I was flirting with you.

Well aren't you?

[TCO]

Originally posted by Imran Siddiqui

You've made it look like I was flirting with you.

Well aren't you?

Go study some bankruptcy law.

[HershOstropoler]

"And so? Really puzzled. Please break it down for me. Is this anything wrong? Bankruptcy is just an adjustment of the financing structure (assuming the entity stays around.)"

Well corporations and bancruptcies are legal constructs. How would an "unregulated" market handle this ? I know this is a fiction, but easy to do for say a purchase. But what is the "market solution" for illiquidity and/or overindebtedness ?

You say "If the bankruptcy law differs from the ideal" - what is the ideal ?

[TCO]

Originally posted by HershOstropoler
"And so? Really puzzled. Please break it down for me. Is this anything wrong? Bankruptcy is just an adjustment of the financing structure (assuming the entity stays around.)"

Well corporations and bancruptcies are legal constructs. How would an "unregulated" market handle this ? I know this is a fiction, but easy to do for say a purchase.

The bankruptcy law has a benefit in that it gives the ground rules for helping a creditor recover part of his assets. And it enforces seniority of debt and the covenants. An unregulated market would almost be like some libertarian fantasy where contracts are not enforced by the government. The result of not having a bankruptcy law would be greater hesitancy to lend. Some of the adjustments might be: higher interest rates, more detailed investigation of who money is lent to (corporate officers character), general preference for equity financing over debt (because of higher debt interest rates)...ummm...I don't know maybe they could keep the CEO's heart in a box? Maybe the banks could hire Guido to get their money back?

I don't see how you can have limited liability corporations without bankruptcy. Bankruptcy just gives a legal mechanicsm to have the debt-holders take over the company and the stockholders walk away.

I'm not srue what you mean by your purchase example. If I buy something and don't pay for it (let's assume not bankruptcy...just don't like to pay) than the law can be used to make me pay. Civil suits and wages garnished, no? Anyway, what's your point re purchases?

But what is the "market solution" for illiquidity and/or overindebtedness ?

I don't know. I'm not sure I understand the question, but if I do, I don't know the answer. Maybe if you gave a specific example, I would see what point you are teeing up more.

You say "If the bankruptcy law differs from the ideal" - what is the ideal ?

Well I'm sure that it does, since everything does. It's just that the manner and extent that it does will affect financing. For instance, I am more likely to get a good bankruptcy proceeding in the US than in Botswana. So the cost of debt in Botswana is higher (there may be other reasons...but this is one.) When people lend money, they have to take defaults into account as part of the risk. Since bankruptcy is how debts are worked out (resolved) when the borrower can't repay (and providing they can't make an arrangment/negotiate a settlement).

Umm...I guess an ideal bankruptcy process would be fair and always correct (no Roe v Wade decisions!) in resolving debt seniority and covenants (wether broken or not). It would be immediate (no time delays). It wouldn't cost any money. No cost for lawyers.* Umm it would have the wisdom of Solomon in approving the value maximizing workout plan (maybe even of devising it). B and M make the point that the Eastern Airlines workout took 2 years and that an immediate liquidation would have served debtholders best, but that at the end of 2 years, the company was ADMINISTRATIVELY INSOLVENT.


*Brealey and Myers, chapter 18 talks about this. They cite some sources which show large costs to the legal process.

[HershOstropoler]

Hmmm... I need to make the argument broader... a few points and questions:

"An unregulated market would almost be like some libertarian fantasy where contracts are not enforced by the government."

Which is why I said it is a fiction. There is a difference, however, if the state just enforces our purchase agreement, or if it creates legal personalities, creditor hierarchies, write-offs etc. So if the state requires that we get an allowance for our purchase, it's clear it is messing with the free decision of market participants. The problem is how to establish that benchmark for bancruptcy law.

"The result of not having a bankruptcy law would be greater hesitancy to lend."

Depends. If you get your debtors as slaves instead of writing off debt....

"I don't know. I'm not sure I understand the question, but if I do, I don't know the answer."

I think you understand, and I don't know the answer either. Which makes it, for example, hard to understand why many simply praise restructuring over liquidation bancruptcies.

[TCO]

Originally posted by HershOstropoler


Which is why I said it is a fiction. There is a difference, however, if the state just enforces our purchase agreement, or if it creates legal personalities, creditor hierarchies, write-offs etc. So if the state requires that we get an allowance for our purchase, it's clear it is messing with the free decision of market participants. The problem is how to establish that benchmark for bancruptcy law.

Not sure where you are going. The creditor hierarchies exist prior to the bankruptcy proceeding. Do you mean just that the court adminsters the process. Yes. That's true. I'm not sure wether that is just an extension of contract enforcement (but in a complicated situation) or if you think it is more. Perhaps it is similar to a court adminsitering a contested will? Maybe you are saying that the court becomes more of an executor? But, we should remember that not all bankruptcies end in court either. Banks and creditors do workouts on their own. It goes to court because the creditors and debtors can;t come to agreement (and debtors are in default) or maybe even because the debtors can't come to agreement even among themselves.

"The result of not having a bankruptcy law would be greater hesitancy to lend."

Depends. If you get your debtors as slaves instead of writing off debt....

That's my point about a limited liability corporation. Common stock equity holders are not responsible for debts. Equity is an implicit call option. The bankruptcy provides a legal process to turn the assets over to the debt holders once the company is insolvent (i.e. equity negative, using face value of debt.) If you didn't have this process of bankruptcy, and had slavery instead you wouldn't have limited liability corporations. I can imagine a more tangible thing like having stock-holders personal assets at risk. Slavery takes it a little far...but to top you, we could go to a "pound of flesh".

"I don't know. I'm not sure I understand the question, but if I do, I don't know the answer."

I think you understand, and I don't know the answer either.

I was honest when I said I didn't understand. I like to try to break things down into very tangible examples. ("Company A does practice B raising issue C with Debt-holder D" or something like that.) Sometimes I'm not sure what claim you're making and I don't want to take the discussion (or even argument) down a long path to find out, "I was talking about something different."

Which makes it, for example, hard to understand why many simply praise restructuring over liquidation bancruptcies.

The WSJ article is just making the simple point that the business may be more valuable as a going concern than if liquidated.

I don't think the article (or I) am in favor of keeping together businesses that would be more valuable if liquidated. I am actually in favor of dismembering NON-BANKRUPT companies that would be worth more liquidated. (This happens sometimes where a company has bad managment, but a big cash pile and the stock is valued at less than the value of cash minus debt.)

[DrSpike]

Originally posted by Colon

Where is Spikey when you need him.

Hehe, a belated entrance. I see the discussion has now moved on to yawn inspiring bankruptcy procedures, but were there any threads left dangling from the more interesting discussion that preceded it?