Bankruptcy May Not Help

As GM goes under and more and more companies consider bankruptcy to deal with sky-high debt and an economy in recession, the question is: will this help the companies?

Researcher Erik Lie thinks these moves might provide only limited help for many. He thinks that companies that enter bankruptcy and then emerge too soon with too much debt, may do poorly when compared to similar companies that manage to survive.

Lie’s earlier research discovered that some corporate executives were illegally backdating stock options acquisitions. This discovery led to the prosecution and conviction of dozens of executives at US corporations.He says, “We found that a firm’s debt is sticky, even through the bankruptcy process, and too much debt and not enough profit is a dangerous combination.”

Lie and his team studied 172 companies that filed for Chapter 11 bankruptcy protection between 1990. These were all “fresh start” bankruptcies, where creditors were given 50% or more of the firm’s equity in exchange for the debt they held.

They found that companies in their sample emerged from bankruptcy with an average profit margin of only 8% percent, much lower than their peers.

Lie warns, “That’s a concern because the long-term debt eventually becomes short-term debt and will need to be paid, and it’s a question whether the companies are profitable enough to make those payments. In addition, such a high debt load makes it more difficult to obtain additional debt in the future, which might be needed to help the firm grow and remain competitive.

“Many of the companies in the research sample continued to have financial problems after emerging from bankruptcy and some have even re-filed for Chapter 11 protection, or so-called “Chapter 22.”

Thus the futures of General Motors and Chrysler may not be bright.

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