Bankrupcy Part 2
B. Volume
Price and return data are not useful if the volume is so small that one
could not buy or sell at the prices given. To determine if this is the case
with our sample, we compared the average daily turnover during the
bankruptcy with the "normal" pre-bankruptcy turnover for the company.
Normal turnover is defined as the average daily turnover in the one year
period ending three months before the bankruptcy. The post-bankruptcy
filing daily turnover was calculated as a percentage of the normal
pre-bankruptcy turnover for each firm using volume and share data
available on the CRSP tape. For example, if 1.0% of a firm's shares
traded on average each day before the bankruptcy and 0.6% traded each
day on average during the bankruptcy, the average turnover during
bankruptcy was 60% of the average turnover before the bankruptcy. The
firms were then separated based on this percentage with the results
shown in Figure 1.
As Figure 1 indicates, volume was relatively high during the bankruptcy
for most of the firms in the sample. Forty percent of the sample actually
had higher average daily turnover during the bankruptcy than before, and
only 18% of the sample had average daily turnover that was less than half
the pre-bankruptcy turnover.
IV. THE STOCK PRICE RELATIVE TO THE REORGANIZATION
PLAN
A bankruptcy essentially has three possible outcomes. The firm can
emerge as a stand-alone company, it can be merged with another
company, or it can liquidate, either under a Chapter 11 reorganization
plan or by converting to a Chapter 7 bankruptcy. The outcomes for the
firms in our sample were determined for all but three companies. These
firms were delisted at prices of 3/8, 5/32, and 3/ 32. No mention of
liquidating, filing a plan or changing the name could be found. These firms
were no longer listed in Standard & Poor's Corporate Register, but no
listing appeared in The 1995 Directory of Obsolete Securities.
Eighteen companies submitted final reorganization plans which eliminated
the shareholders' interest, including six plans that called for the liquidation
of the firms' assets under Chapter 11. Four others converted to Chapter
7 and liquidated, paying nothing to the shareholders. Three firms sold off
all of their assets and paid nothing to their shareholders, although we
could not determine if this was under Chapter 7 or 11. Assuming
shareholders in the three companies that "vanished" were paid nothing, 28
of 68 companies (41%) trading one month after filing for bankruptcy gave
nothing to shareholders.
The median share price of these 28 companies was $0.44 the day after
the bankruptcy and $0.56 one month after the bankruptcy. Six of the
firms ultimately giving zero were trading above $2.00 per share one
month after the bankruptcy, with Continental Airlines above $8.00.
Interestingly, the 40 firms which gave something to the shareholders also
had a median price of $0.56 one month after the bankruptcy, but a
median price of $0.75 the day after filing for bankruptcy.
Did the stock price incorporate the publicly available information revealed
by these companies? The value to shareholders under a reorganization
plan can sometimes be very difficult to estimate. A plan might call for a
significant dilution of equity, or it might give only warrants to the old
shareholders with an exercise price well above the expected stock price.
However, for 28 companies in our sample no ambiguity exists as to the
value that the old shareholders would receive: 25 companies giving
shareholders absolutely nothing as part of a reorganization or liquidation,
and three companies whose shareholders were given cash under the plan.
Let the "announcement date" be the date the company filed a plan giving
shareholders cash or nothing, or the first time the firm announced it would
liquidate. The bankruptcy may still continue for many months, with the
plan being further amended to placate certain creditors.
Sixteen of the companies giving zero and one company giving cash
($0.01 per share) were delisted prior to the announcement date. Table 1
examines the remaining eleven companies in greater detail. Three firms
(Pan Am, Valley Industries, Continental Information Systems) were
delisted because of the announcement. The shares of six companies filing
plans to eliminate the pre-bankruptcy shareholders' interest were actively
traded after making their intent public. Is the trading in the stock of these
companies consistent with market efficiency? Table 1 shows the price the
day before the announcement, the day after the announcement and the
high price after the announcement. Although the announcement
immediately sent the price of these companies down to $0.57 or less,
four of these companies experienced subsequent price increases of 50%
or more. Consider that the high for four of the six companies giving zero
was above the closing price before the announcement even though the
worst case scenario had occurred. Continental Airlines actually closed as
high as $1.50 per share, or 50% above what the price was before the
firm announced shareholders would get nothing.(6) Bay Financial closed
as high as $0.68, or more than 500% above the ten cents shareholders
were slated to receive under the plan. This was over 300% above the
value before the announcement. As the last column of Table 1 indicates,
average daily turnover for these eight companies was not trivial. In fact,
average daily turnover after the announcement averaged 92% of average
daily volume before bankruptcy.
Consider the hypothetical portfolio of $1000 worth of stock purchased in
each of the eleven companies in Table 1 at the closing price one day
before each company's announcement. The next day, the value of this
portfolio according to the liquidation or reorganization plan was $860,
since only Bay Financial and Allegheny International have value. Yet the
market value of this portfolio was $8366, or 873% above the value
according to the announcements. Since none of the plans were altered in
the shareholders favor, the final value of this portfolio was $860.
Most investors purchasing stock in a company listed in Table 1 probably
did not understand the bankruptcy process and were therefore either
unaware of the [TABULAR DATA FOR TABLE 1 OMITTED] plan
provisions or overestimated the likelihood of a favorable plan revision. It
is also possible some investors did not even realize the company was
bankrupt.(7) If investors bid up the value of these securities because they
were unaware of the plan provisions, or that the firm was bankrupt, then
the stock price clearly did not reflect publicly available information.
If all investors were familiar with the plan provisions, then Table 1
suggests that investors overestimate the likelihood of a favorable plan
revision. Table 1 shows what the shareholders received under the plan
that was ultimately confirmed by the bankruptcy court and consummated
by the firm. Clearly the reorganization plan can be revised to include
shareholders. However, the evidence suggests that this probability is
extremely small since none of the 28 firms initially giving zero or cash to
the shareholders amended their plans to give the shareholders more.
Table 1 includes only companies giving zero or cash. The stock price of
companies giving something to shareholders might also not reflect what
the shareholders are likely to receive upon reorganization.(8) To
determine if investors overestimate the value ultimately received, we
examined the return to all firms whose stock was trading one day after
filing its first plan. Forty-two firms met this criterion, including nine of the
firms from Table 1. We compared the stock price after the first plan was
filed with the value after the plan was confirmed and one week after the
firm emerged from bankruptcy.(9)
The results are provided in Table 2. Note that in the table we report raw
returns and market-adjusted returns. The standard performance measure
in the literature is the "abnormal return," where the normal return is
estimated from the market model using daily rates of return. Abnormal
returns cannot be calculated for this sample for a variety of reasons. First,
use of the market model to calculate abnormal returns assumes the
regression coefficients do not change over the estimation period. This
assumption is unrealistic for bankrupt firms because firms often sell assets
(sometimes exiting from certain industries entirely), change management
and/or become merger targets, all of which change the firm's relationship
with the market portfolio. Furthermore, firms often attempt to negotiate
with creditors prior to the bankruptcy, which may affect the stock price
during the estimation period. Similarly, the bankruptcy bargaining
process, a non-factor before the bankruptcy, becomes a major influence
on the bankrupt stock. Since betas cannot be reliably estimated, we
examine raw returns. Furthermore, since the CRSP NYSE/ASE value
weighted, total return index rose at an annual rate of 12.3% from
1988-1995, market-adjusted returns are also provided, using this index
as the market return.(9)
Ten of the forty-two firms were delisted prior to the confirmation date,
including five of the firms giving zero consideration and two of the firms
giving cash. Of the other three delisted companies, Orion Pictures and
National Convenience Stores emerged from bankruptcy with publicly
traded securities so that a value could be determined after the effective
date. Winjak's plan was confirmed although its new stock was never
publicly traded and the company was removed from Standard & Poor's
Corporate Register the following year but was not listed in The 1995
Directory of Obsolete Securities. To calculate a return to the confirmation
date, the delisting price was used for Winjak, the first available price after
the effective date was used for Orion Pictures and National Convenience
Stores, and zero or the final cash value was used for the companies giving
no consideration or cash respectively.
A value could not be determined for thirteen firms one week after the
effective date. The first available stock price for three firms was used,
although this price was not available until several weeks after the effective
date. The price on the effective date was used for four firms for which a
value could not be determined after the bankruptcy either because the
firm was purchased by a company whose shares were not actively traded
or because the shares of the company itself were not actively traded. Five
firms gave warrants or contingent securities to their shareholders which
were far-out-of-the-money and had no market quote available. This
includes three firms that gave only warrants to their shareholders. As of
June 1995, the warrants were still out-of-the-money. Returns were
calculated assuming these securities were worthless. The returns are
slightly understated to the extent that far-out-of-the-money options are
not totally worthless.(11)
The average return from the day after the plan is filed until the day after
confirmation of the plan is -21.8%; through the effective date the return is
-37.9%. Market-adjusted returns were even lower: -33.4% through the
confirmation day and -49.0% through the effective date. Only ten of the
42 firms had positive raw returns through the confirmation. The mean
returns were significantly raised by just two companies, including Conston
which filed for Chapter 11 protection again three months after emerging
from bankruptcy . Thus, investing in the stock of bankrupt companies
after they have filed reorganization plans seems to be a losing proposition.
Tables 1 and 2 suggest that investors overestimate what will ultimately be
received upon reorganization after a plan has been filed. In not a single
instance do the shareholders receive more in a subsequent reorganization
plan than they were to receive under the original plan. Especially in the
cases where the old shareholders' interest are to be eliminated, either
receiving nothing or some small cash payment, the shares continue to
trade at what appears to be unreasonably high prices. Even in the cases
where the old shareholders keep their shares, the shares tend to be
overvalued at the time of the plan filing, so that investors who hold the
shares through plan confirmation (or consummation) suffer substantial
losses on average.
Finally, Table 2 also illustrates that the submission of a reorganization plan
does not signal that the end of the bankruptcy is near. Over six months
elapsed for the median firm between the submission of the first plan and
the confirmation of a plan. |
