corporate distress

8/11/2019 Corporate Distress

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2/41Electronic copy available at: http://ssrn.com/abstract=1704411

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C o r p o r a t e F i n a n c i a l D i s t r e s s a n d R e c o v e r y :

T h e U K E v i d e n c e

1. Introduction

A number of previous studies view financial distress not only from the cost

perspective but also from its benefits. For example, Kaplan, 1989, Smith, 1990,Baker & Wruck, 1989, Kaplan & Stein, 1990, show that financial distress often

results in wide ranging comprehensive organizational changes in governance,

management and structure which can create value by improving the use of resources

and improving efficiency. The event of financial distress forces the management to

set up comprehensive organisational changes in management, governance,

operations, and in asset, equity and liability that would not have occurred when the

firm is financially healthy, as, before companies get into a state where private

workouts or legal reorganisations become imminent, they usually undertake

measures that allow them to recover their financial health.1

In an extensive study on financial distress and corporate turnaround Loui and

Smith (2007) conclude that previous studies identify the top management change as a

pre-requisite for any successful recovery. The choice of a particular strategy depends

on a number of factors such as the bargaining power of debtholders, blockholders

and managerial shareholders, and the strategies usually follow two-stage approach

incorporating operating/efficiency turnaround stage to stabilize operations and the

entrepreneurial/strategic stage to restore profitability. These two simultaneous

strategies span over both short- and medium-term as they aim at stopping the

situation getting any worst by reducing direct and overhead costs, increasing

revenues and rationalizing assets, and, at the same time, designing a longer term

strategic plan for what the company will look like in the following few years to

maintain or improve production.

The choice and design of

these strategies, together with their effectiveness in allowing companies to regain

financial health, have widely been debated in the literature.

However, there is a controversy as to which strategies are efficient and lead

companies to full recovery. For example, Pearce and Robbins (1993) suggest that

acquisitions which might be undertaken to improve production in case the firm is in

mature or declining markets might be undertaken to promote apparent growth, but

without being sustainable. They also argue that turnaround success or failure depends

more on strategy implementation than on strategy choice. Sudarsanam and Lai

(2001) report that while divestment of assets is the most popular recovery strategy


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especially amongst large companies, and may be crucial to regain financial health,

particularly when the level of distress is very high, its importance in achieving

successful recovery is mixed. They also show that the recovery strategies are

relatively similar across recovered and non-recovered firms, results that could be due

to the fact that they did not distinguish between the strategies that are available to

distressed/declining firms and other firms (Ashta and Tolle, 2004). The analysis of

financial distress poses also additional problems. First, given that clear and reliable

information can be particularly difficult to obtain during the period of financial

distress, the valuation of distressed companies can be so complex and the decisions

about potential actions can be debatable. Since different reorganisation policies will

distribute wealth differently, the conflicts in decision making would be inevitable.

According to Kaback (1996) and Dalton and Daily (2001), such conflicts can even

lead to bias or inaccurate data being presented by groups pursuing their own agenda.

Finally, previous studies provide conflicting evidence because of lack of standard

definition of financial distress. For example, Wruck (1990) states that a firm is in

financial distress when it is it is unable to meet current cash obligations, referring to

insolvent on a flow basis, while Altman (1968) refers to insolvency when the firm is

bankrupt.

The purpose of this paper is to analyze all the strategies undertaken by a

sample of distressed companies and assess the extent to which some strategies areefficient. We do this by analysing the appropriate post distress financial

characteristics in the light of these strategies. Unlike most previous studies, we

follow DeAngelo and DeAngelo (1990) and define financially distressed companies

as those that have three consecutive years of negative net income. This definition

allows us to avoid using outcome based definitions like bankruptcy or being taken-

over because, such outcomes are a consequence or resolution/exit paths adopted by

companies that are financially-distressed. We distinguish between companies that

adopt immediate cash conserving and cash generating strategies, those that indulge in

cash depleting strategies, and those that adopt strategies that have nothing to do with

cash at all, or undertake all or varied combinations of these measures to regain

financial health.

To do this, we first select 456 financially distressed companies out of 5,500

UK companies on the basis of a profit immediately before suffering 3 consecutive

years of negative net income, following DeAngelo and DeAngelo (1990) definition.

This selection criterion allows us to focus on initially healthy companies insofar as,


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in the year before their initial loss, they had a positive net income, and then carried

on having three consecutive years of losses. We then analyse 8,503 news

announcements made by our sample firms over the period from 1980 to 2004. We

split all the news announcements into 4 main categories and assess the differences in

strategies, as reflected in the types of news announced, between recovered and non-

recovered firms. We focus mainly on cash generating/conserving as opposed to cash

depleting strategies.

We find that our companies adopt many strategies in an attempt to recover

from financial distress without resorting to bankruptcy as an exit route. More

importantly, whilst the recovered and non-recovered companies undertake similar

strategies, the recovered companies are stricter, more efficient and focussed in

implementing the said strategies. Recovered companies also undertake more

financial and cash conserving strategies as opposed to the non-recovered companies,

which undertake more of asset-based and cash depleting strategies.

The rest of the paper is organised as follows: Section 1 presents the

theoretical background and the hypotheses to be tested. Section 2 discusses the data

and methodology. Section 3 discusses the empirical results. The conclusion is

presented in section 4.

1.

Theoretical backgroundSlater and Lovett (1999) provide an extensive review of the generic

turnaround strategies companies in trouble can adopt and outline their essential

ingredients for a successful turnaround. These strategies include crisis stabilisation,

leadership, stakeholder support, strategic focus, organisational change, critical

process improvements and financial restructuring. Operationally, these strategies

emerge from, for example, cost reduction, changing management, redefining

business, investing, downsizing, and raising funds. Consistent with these arguments,

Wruck (1990) document that financial distress is often accompanied by

comprehensive organisational changes in management, governance and structure.

However, in practice, the choice of a particular strategy depends on several factors

including the bargaining power between the management, shareholders and

debtholders. For example, previous studies (e.g., John, Lang and Netter (1992), Ofek

(1993) and Kang and Shivdasani (1997)) argue that leverage is critical to the success

of any restructuring strategy. Grinyer, Mayes and McKiernan (1988) find that one of

the major differences between recovering and non-recovering firms is that the former


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make more management changes. They also identify financial restructuring as a

necessary component of any turnaround strategy.

Generically, the strategies adopted by companies could be grouped into short

and long term strategies.Short-term strategies are expected to stop the worsening of

the financial distress situation by reducing direct and overhead costs, increasing

revenues and rationalizing assets. The long-term strategies aim at designing a

strategic plan to signal to investors how the company will look like in the future.

Carapeto (2005) classifies operational and financial restructuring as short term

measures and asset and management restructuring as long term measures. However,

there is no clear reasoning behind this type of classification and in some cases a short

term strategy like dividend cuts (financial restructuring) can be termed as a long term

strategy, as is evidenced in the findings of Benartzi et al (1997), who find that,dividends cuts are left as a last resort in case of financial distress. Given that

financial distress is likely to driven by the firms cash shortage, an appropriate

classification should be related to turnaround cash management. These strategies are

undertaken mostly to remedy the faltering (cash) status of the financially-distressed

company.

1.1. Generic restructuring strategies

In this paper, we conduct our analysis on the basis of the 4 main generic

restructurings strategies and distinguish between cash generating (CG), cash

conserving (CC) and cash depleting (CD) strategies. The following sections provide

a summary of these strategies that form our fundamental hypotheses.

Operational restructuring

This is generally the first broad strategy undertaken by companies. It includesmeasures to boost revenue generation, improve efficiency by reducing operating

assets, reducing investment, spending (capital, R&D) and costs (COGS), retrenching

and increasing focus, shrinkage by laying off employees. Some of these measures

typically either conserve or generate cash. Sudarsanam and Lai (2001) refer to

operating asset reduction strategies as those that involve business unit level sales,

closures, integration of surplus fixed assets such as plant, equipment, offices and

reduction in short term assets such as inventory and debtors. This last point is also

theorised by Bibeault (1982) where he suggests that that there are 4 key factors in


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achieving a successful turnaround (i) a financially and competitively viable core

operation has to be identified and achieved (if necessary by slimming down

operations); (ii) employee motivation had to be maintained or increased; (iii)

sufficient financing had to be negotiated to sustain in the turnaround period and (iv)

there had to be new, energetic, competent and fully supported management in place.

Others, such as Schendel et al. (1976), and Hofer (1980) have also found similar

corroborating evidence. John et al. (1992) find that the most common responses are

the contraction policies, namely, asset sales, divestitures, spin-offs, employment

reduction, debt reduction, focussing on core business and plant shutdowns. They

show that about 63% of their firms2

However, Sudarsanam and Lai (2001) argue that operational strategies may

be a necessary but not sufficient condition for recovery. Zimmerman (1989) findsthat recovered companies are also diligent, disciplined and maintained their costs

low, unlike the unsuccessful companies who tried to increase revenue by focussing

on external expansion, acquisition or financial restructuring. John et al (1992) find

that their recovered companies cut their research and development and advertising

expenses and reduced leverage rapidly. Robbins and Pearces (1993) argue that

successful firms undertake first the efficiency/operating turnaround strategy and then

the entrepreneurial/strategic stage (see also Bibeault (1982) and Slater (1984)).

adopt this focus strategy.

Asset restructuring:

This strategy involves selling off assets through divestments, spin-offs, and

equity carve-outs, merging with another company, and acquiring assets. It typically

generates much needed cash quickly but it is considered to be a drastic option (e.g.,

Robbins and Pearce (1993)). Sudarsanam and Lai (2001) find that, distressed

companies divest non-profit generating assets, non-core assets and even profitableassets to raise cash to pay off debts and avoid bankruptcy, and make the management

focus on business segments where the company has a comparative advantage. Datta

and Iskandar-Datta (1995) find that financially-distressed companies divest assets

equally both before (69.6%) and after (65.9%) filing for bankruptcy. However,

though a popular measure of raising cash while in distress, asset sales may not be

optimal because financially distressed companies may not get a good price for their

assets (e.g., Gilson et al, 1990, Weiss and Wruck, 1998, Shleifer and Vishny, 1992,

DeAngelo et al, 2002, Hart (1993) and Hart and Moore (1995)), but its popularity is


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likely to be driven by the positive market reaction to this announcement of this

strategy (e.g., Brown et al (1994), Lang et al (1994) and Lasfer et al (1996)).

The second strategy in this respect relates to mergers and take-overs to gain

from various types of synergies. Grinyer et al (1988), introduce the theory of sharp

benders (companies that achieve sudden dramatic improvement in performance) and

find that following decline (in relation to competitors), financially-distressed firms

achieve dramatic and sustained improvement and that they do not restrict themselves

to operational cost reduction strategies but shift to long term strategic changes

through diversification, acquisition, and new product market focus. Similarly,

Carapeto (2005) points out that, financially-distressed companies enter into asset

restructuring in the form of investments by forming strategic alliances, joint ventures

and licensing agreements. However, in most cases, they need to find funding toundertake such strategies because they are typically cash depleting strategies.

Financial restructuring

This strategy typically includes (re) negotiating with banks and other

creditors (CG/CC), issuing new security (CG), cutting/omitting dividends (CC) and

exchanging debt for equity (CC). This type of restructuring involves debt and/or

equity restructuring and can either generate or conserve cash. Gilson (1989, 1990)

defines debt restructuring as a transaction in which existing debt is replaced by a new

contract with one or more of the following characteristics: (i) interest or principal is

reduced (CC) (ii) maturity extended (CC) (iii) debt is swapped for equity (CC). In

about half of all the cases, financially-distressed companies restructure their debt

privately (Gilson et al, 1990). Datta and Iskandar-Datta, (1995) substantiate this

finding and document that nearly 50% of companies that undertake financial

restructuring are successful in renegotiating the terms of their debt contracts. Themost common strategies include covenant modification, maturity extension, interest

rate adjustments, tender offers, and equity/cash for debt swaps. Gilson et al (1990)

conclude that financially-distressed companies with relatively higher going concern

value are likely to opt for private debt restructuring since more value is lost in

Chapter 11 reorganisations. Along the same lines, Ofek (1993) finds that in the case

of short-term financial distress, higher leverage increases the probability of debt

restructuring and the relationship between the two is positive and significant when

the debt is private. Companies that face short term financial distress are less likely to


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annual loss is an essential necessary (but not sufficient) condition that needs to be

satisfied for dividend reductions. These results suggest that dividend cuts are not

solely driven by agency and/or signalling considerations. However, Benartzi et al

(1997), find that companies that cut dividends experience a very large drop in

earnings the year of cuts, suggesting that dividend cuts are left as a last resort and

perhaps are not the most favoured means of conserving cash. Ofek (1993) notes that

leverage significantly increases the probability of dividend cuts in poorly performing

companies and shows that the higher the leverage, the larger the dividend reductions.

Franks and Sanzhar (2003) document that dividend omissions occurred in 95% of the

distressed rights issue cases and 92% of the distressed open offer cases. In other

words, the proportion of companies that omitted their dividends does not depend on

the new issue method used as more than 90% in each sample omit dividends

suggesting that financially-distressed companies do not raise equity to cover their

dividend payments.

Management restructuring

This last, but not least, strategy involves changes in the management of the

company and it does not directly involve cash. Companies enter financial distress as

a result of economic distress, a decline in the companys industry and poor

management, (Wruck, 1990; Campbell and Underdown, 1991). Whitaker (1999)

finds that well managed companies that enter into financial distress as a result of

industry decline would seem less likely to benefit from corrective management

actions than would those that enter due to the effects of poor management. On the

other hand, improvement in industry economic conditions is a significant

determinant of recovery for companies in economic distress but not for those that

were historically poorly managed (see Whitaker, 1999). Wruck (1990) quotes the

example of Massey Fergusson, which exemplifies the management of a deteriorating

company in the absence of financial distress; the management may or may not even

be aware that they are mismanaging the company or that the strategies chosen are

inappropriate. It could also be that managers are reluctant to undertake actions like

layoffs, and discontinuing operations, if there are no immediate cash flows. Ofek,

(1993) argues that the larger the shareholding by managers, the lesser chance of

operational actions being taken, especially if these actions do not generate cash

inflow. In many instances, a successful turnaround means that a management teamcommitted to a poor strategy is changed. Datta and Iskandar-Datta (1995) find that


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58.51% of the sample companies experience a change in senior level management in

the pre-filing period and in the post filing period this change is 47.41%. This latter

part of the finding is interpreted as Chapter 11 is soft on management (Bradley and

Rosenzweig, 1992). Brown et al (1994) provide evidence that when proceeds of asset

sales are used to repay debt, the management turnover is less likely, implying that the

creditors exert influence over management decision making. Gilson (1990) finds that

the managers, who depart from a financially-distressed company, do not hold a

senior management position at other listed companies during the following three

years and that senior level management change occurs in 52% of all the sampled

companies during the financial distress period, compared to 19% for healthy firms.

Similar results are documented by Zimmerman (1989) who shows that the chief

turnaround agents were much more experienced in the respective industrial fields

the companies belonged to.

In the UK, ineffective implementation of fiduciary responsibilities results in

non-executive directors regarding their role as primarily advisory rather than

disciplinary. Moreover, neither existing nor new purchasers of large share blocks

exert much disciplining and bidders impose high board turnover after takeovers but

in an unfocussed way. It is only when there is financial distress requiring equity

issues and capital restructuring that disciplining is both significant and focussed on

the management of the poorly performing companies (e.g., Frank, et al (2001)).3

1.2. Hypotheses

Overall, previous studies report that cash generation and/or cash conservation

are of paramount importance in the immediate vicinity of financial distress.

According to DeAngelo et al (1992) the magnitude of the losses, not how long the

company suffers from losses, determines the type of strategies it would undertake.

However, it is difficult to assess the level of losses that would trigger a particular

type of restructuring because each companys threshold is specific and depends on its

fundamental factors, such as capital structure, market position, and macroeconomic

factors. In the US, Datta and Iskandar-Datta (1995) find that nearly 3/4 th of

companies undertake asset restructuring (69.63%) and governance restructuring

(71.85%) before filing for bankruptcy while only one-fourth of companies undertake

labour (24.44%) and financial restructuring (28.15%) during this period. In the UK,

the results are still mixed.


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The purpose of this paper is to assess the types of restructuring strategies that

allow UK firms to recover from financial distress. Franks and Sussman (2005) have

shown that in the UK, despite the concentration of liquidation rights in the hands of

usually one lender, 75% of the financially-distressed companies recover and one-half

of the companies placed in bankruptcy are actually sold as going concerns. This

implies that the majority of the financially-distressed companies survive because

they undertake immediate and successful (in most cases) strategies that allow them to

regain financial health. The question, however, remains as to what type of strategies

they undertake. We first assess whether financial as opposed to operational strategies

are more efficient mainly because the latter induce some costs. For example, layoffs

are costly and closures and integration of business units can be time and sometimes

resource consuming, leaving cost rationalisation as the only easily implementable

operational restructuring activity in the short run. Spin-offs increase the firms

market value in the short term as markets react positively on the announcement date

but they do not generate cash (e.g., Allen and McConnell (1998)). Although

divestments and equity carve-outs can generate immediate cash, they are time

consuming as they include decisions on which assets to divest, liquidity discounts on

the asset, possible layoffs and problems of finding buyers, especially if the asset is

not deployable. These practicalities would make asset sales relatively difficult to

implement in the short run. On the other hand, financial restructuring strategies, suchas dividend cuts, omissions, rights issues, scrip dividends, debt refinancing and debt

equity swaps are rather easily and quickly implementable. Franks and Sanzhar

(2003) report that these strategies are common practices in the UK. However, they

could result in further decrease in share prices. These arguments suggest that

financial restructuring is likely to be more efficient strategy. Therefore,

H01: Companies that recover are likely to adopt more financial strategies than

operational, asset and governance strategies.

Surviving financial distress does not mean recovering from financial distress,

but simply means that the companies are able to carry on functioning year after year

despite making 3 consecutive losses or being financially distressed. Recovering from

financial distress would mean making profits once again after suffering protracted

periods of losses. To be able to do so, financially-distressed companies must, in

theory, undertake strategies that conserve cash and or generate cash or in some casesundertake strategies that perhaps immediately deplete cash but in the long run to


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allow them to regain their financial health. We also hypothesise that the recovered

companies in our sample will be more active in terms of the cash generating or cash

conserving strategies. More specifically, whilst studying different aspects of financial

distress, previous studies report that companies in distress, adopt in one way or

another, measures to generate or preserve cash (e.g., DeAngelo and DeAngelo

(1990), Shleifer and Vishny (1992), Brown et al (1994), Datta and Iskander-Datta

(1995), Lasfer et al (1996)). We therefore hypothesise as below,

H02: Companies that recover are likely to be more efficient and adopt more cash

generating or cash conserving strategies.

2. Data and methodology

We collect accounting data for over 5500 UK companies from the Company

Analysis database, for the period from 1980 to 2004. We exclude financial and

utility companies because of their specifications and ended up with 2276 companies.

Previous studies provide different definitions for financial distress, including

accounting based measures such as losses (DeAngelo and DeAngelo,1990) or Z

Scores (Altman, 1968; Taffler; 1984), stock market performance based (Gilson,

1989), credit rating based relating to down-grading of debt (Franks and Torous,

1994) and outcome based: Bankruptcy (Wruck, 1983; Datta and Datta, 1995). In our

paper we follow DeAngelo and DeAngelo (1990),4and identify financially distressed

companies as those that make a profit immediately before suffering three consecutive

years of negative net income.5We consider financial distress as a situation where a

company makes losses, and is thus unable to meet its financial obligations, and

therefore, we refrain from identifying insolvent companies as financially-distressed

companies. A negative net income allows us to identify companies that are perhaps

solvent companies (i.e. have been able to meet their debt/financial obligations) but

are financially-distressed because they make net losses. The condition for profit

immediately before three consecutive losses is pertinent, because it allows us to

focus on initially healthy companies insofar as, in the year before their initial loss,

they had a positive net income. We call this definition as +--- where the third year

of loss is year T0, the years preceding T0 are T-1 and T-2 respectively and the year

with positive net income that immediately precedes the 3 consecutive losses is year

T-3.6

Figure 1: Identifying the distress and post distress period

Figure 1 provides a schematic representation of our sample selection.


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However, the choice of negative earnings as a definition for financial distress

has limitations. For example, DeAngelo and DeAngelo (1991) argue that

management may reduce reported earnings during labour negotiations to strengthen

their bargaining position. However, in general, companies are more likely to increase

than decrease their earnings and to create value through earnings management (e.g.,

Miglo, 2007). Therefore, the fact that a firm reports losses is a manifestation of an

important event, and, as such, the use of a very strict definition of consecutive

negative net income is likely to serve as a suitable proxy for financial distress. Our

more restrictive definition allows us to eliminate a limitation of John et al (1992)

who use only one year of negative earnings followed by 3 consecutive years of

positive net earnings. However, such a company could have had many more years of

negative earnings in the sampled period (of the total sample of 46 companies

analysed in the study, 21 companies have more periods of negative earnings between

1980-87) but only the last year of negative earning followed by positive earnings is

considered. They acknowledge that given the nature of their definition, their results

may not capture the strategies adopted by their firms.

Our definition has resulted in 456 financially distressed companies. In order

to analyse the strategies undertaken by these companies, we need at least 3 years of

post distress data. This has resulted in a final sample of 258 financially distressed

companies. We compare the strategies adopted by the non-recovered companies to

those undertaken by recovered ones defined as those that have at least 2 year of

profits in the 3 years immediately following 3 consecutive losses. This definition

gives a balanced sample of 123 recovered companies and 135 non-recovered

companies. We collect a total of 8,503 news announcements from the Perfect

Analysis database (previously known as Hydra), 4,059 of which are made by the

recovered companies and the remaining 4,444 by the 135 non-recovered firms. We

then classify them into the 4 generic strategies, namely, operational, financial, asset

and management restructuring and then into cash conserving, cash generating, cash

depleting and non-cash strategies. Table 1 reports this two way classification.

[Insert Table 1 here]

T-3 T-2 T-1 T0 T+1 T+2 T+3

Year of

Profit

Distress Period: 3 Consecutive

Years of Negative Ne t Income

Post Distress Period


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We include layoff in CC strategy group in the medium-term although in the

immediate short term, layoff is associated with cash outflows as it involves

compensation payouts in majority of the cases. Similarly, closures can be argued to

be CD as well since they involve layoffs but since closures are also closely

associated with immediate asset sales, we include them in the CG strategies.

Management restructuring cannot be classified as any of the cash activities.

We then analyse the intensity of the restructuring strategies by computing the

frequency of each strategy by computing the cumulative number of occurrences. For

instance, if a company announces cost cuts and layoffs then operation restructuring

for this company in this year is 2. By getting a cumulative number of each of the sub-

headings of each of the four main restructuring activities, we are able to weigh the

respective strategies and this allows us to determine the intensity of restructuringactivities undertaken.

Finally, we compare these frequencies across the recovered and non-

recovered firms and then run a set of logit regressions to stratify between the two

samples. The dependent variable is dichotomous and is 1 for recovered companies

and 0 for non-recovered companies. The independent variables are the restructuring

variables. All the restructuring variables are therefore dichotomous variables taking

the value of 0 or 1 depending on whether or not a particular strategy has been

adopted by the company. The following regression model is tested:

imij

itititit

itititit

itititit

itititit

YearIndustryCostsEfficiencyManagement

placementsOutsiderplacementsInsiderptsOutsiderAptsInsiderApp

essChangeBuMBOsDisposalnAcquisitio

RaiseDebteRightsIssumissionsDividendOmtsDividendCu

essnofBuIntegratioLayoffsalisationCostRationeredNon

+++

++++

++++

++++

++++=

1716

15141312

111098

7654

321

ReRe

sin

sincovRe)(

In the case of Operational restructuring, we exclude Closures from the

regression because it is highly correlated (79%) with layoffs. We control for size,

industry and years by using the requisite dummy variables. The level of Total Assets

in T-3 (the year before the losses set in) is used to construct the size dummy. We find

that 88 firms (34%) are from the cyclical services, which include General retailers,

Leisure and hotel, Media and entertainment, Support services, and Transport. In

contrast, in the resources sector, there are only 12 firms (5%). The remaining sectors

are evenly represented. We also control for Management Efficiency and Costs using

Sales/Total Assets and Cost of Goods Sold/ Sales.


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3. Empirical Results

3.1. Univariate analysis

Table 2 presents an overview of the news releases for both the recovered and

non-recovered companies. In both cases, the number of news released during the

distress period is much higher as compared to those released in the post distress

period. It is interesting to see that, the recovered companies have more operational,

financial and asset restructuring news announcements whilst the non-recovered

companies have higher proportion of management announcements. Panel C indicates

that apart from financial restructuring news, on the whole, each of the 3 restructuring

news is significantly different from each other for the recovered and non-recovered

companies at 1% and proportion of financial restructuring news releases are

significantly different at 5%. The results indicate that the recovered companies have

higher number of operational and asset restructuring news but lower financial, board

and other restructuring news compared to the non-recovered companies.


Table 3 presents a summary of the different strategies undertaken by both sets

of firms during the distress period. Panel A. indicates that while the operating

restructuring strategies are relatively the same across the two samples, recovered

companies have undertaken significantly more financial restructuring than non-

recovered firms. In contrast, in terms of asset and board restructuring, non-recovered

firms are more active. Similar results appear when cash strategies are analysed in

Panel B. The results show that while cash generating strategies are relatively

homogeneous across the two groups, recovered firms have significantly higher cash

conserving strategies but lower cash depleting strategies. Overall, recovered firms

have significantly more cash generating and cash conserving strategies (86% vs. 68%

for non-recovered firms). However, this superiority is related more to cash

conserving than to cash generating strategies. Finally, Panel C. reveals that recovered

companies are on average larger, generate lower losses, and have higher leverage

than non-recovered firms. These results indicate that the recovery is likely to be

driven by the differences in these fundamental factors, although when we looked at

the means (not reported for space considerations), we find that only return on assets

is statistically significant (-0.18 vs. -0.28,p = 0.08) while the two samples are similar

in their total assets (142m vs. 123m,p = 0.652) and leverage (0.34 for both sets of


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firms,p = 0.90). The differences in mean and median efficiency as measured by costs

of goods sold over sales are not significant, suggesting that the two sets of firms have

the same operating performance, thus probably similar business risk.


3.2. Regression analysis

In order to study whether or not a particular strategy has a significant effect

on whether a company recovers or not, we run logit regressions with a binary

dependent variable which is 1 for recovered companies and 0 for non-recovered

companies. We employ the restructuring variables summarised over the distress

period, after controlling for size, efficiency, industry differences. We also include

year dummies. We first present Table 4 presents the correlations between the

variables. As expected the results indicate strong correlations between the strategies

indicating that companies do not take only one strategy at a time but a combination

of them. For example, the correlation between layoffs and cost rationalisation is 0.4

suggesting that these two strategies are taken together. However, some other

strategies appear to be unrelated. For example, dividend cuts are not strongly

associated with costs rationalisation, layoffs, MBO/spin-offs, and insider

appointment/replacement. In the regression results, we control for the resulting

multi-collinearity.


Table 5 reports the logit regression results where the dependent variable is

equal to 1 if the company recovers and zero otherwise. Amongst the operational

restructuring variables, only Layoff is significant (at 1%) and has negative

coefficient. This implies that higher the layoffs more likely the company will not

recover. It can be argued that in the immediate near term layoffs are expensive given

that the usual immediate associated action along with layoff is compensation to the

laid off personnel. The regression results show that lesser the layoffs higher the

chances of recovery implying that in this case layoffs are indeed cash depleting

strategies in the near term. However, intuitively layoffs still remain cash conserving

strategies as opposed to cash depleting strategies. Cost cuts and integration of

business units are not significant. It has been seen that, the recovered companies doundertake operational measures but this is much less as compared to the non-


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recovered companies. In the past, corporate performance decline has been generally

attributed to managerial inertia, delayed timing and lack of focus and proper

implementation (Schendel et al, 1976; Hofer, 1980; Hambrick and Schecter, 1983;

Weitzel and Jonsson, 1989; Barker and Mone, 1994). Sudarsanam and Lai (2001)

note that operational restructuring (we use the same 4 categories that they use to

identify operational restructuring) is designed to primarily to generate cash flow in

the short term and that it is of fire fighting nature and differs from restructuring

aimed at longer term performance of the company. They conclude that, operating

restructuring may be a necessary but not sufficient condition to recover.

When we regress only the operational restructuring variables as independent

variables to see just how these on their own affect the recovery or non-recovery of a

company, we find that cost rationalisation is negative and significant at 10% whilstlayoffs is highly significant and is negative too. Integration of business in the distress

period is highly significant and is positive. This implies that, on its own, integrating

business in the distress furthers recovery to some extent. This also implies that,

whilst layoffs is strongly significant in explaining recovery/ non-recovery, to borrow

the term used by Sudarsanam and Lai (2001), cost rationalisation is only strongly

suggestive in this case.

All the financial restructuring variables are significant. Dividend cuts and

Omissions and Raising Debt in the distress period are all positive and significant at

1%, whilst Rights issue is negative and significant at 5%. This implies that, the

increased undertaking of dividend cuts, omission and raising debt in the distress

period increases the chances of recovery whilst increased equity issues in the distress

period reduces the chances of recovery. It has been seen before that, dividend cuts

and omissions along with rights issues are the most popularly reported strategies

undertaken by our sample of companies. Sudarsanam and Lai (2001) suggest that

non-recovered companies may be forced to cut or omit dividends or restructure debt

more intensively in the years following distress (in their case distress is based on z-

score) because of their failure to recover in the initial years of distress. They

therefore, comment that dividend cuts or debt restructuring may merely contribute to

survival and that they may be necessary but not sufficient conditions to recover.

In this case, it can be seen that the proportion of such strategies being

implemented in case of the non-recovered companies is less compared to the


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recovered companies from the outset, i.e. recovered companies are more aggressive

in implementing dividend cuts or omissions and raising debts in the distress period.

Non-recovered companies distinctly implement the said restructuring activities much

later in the distress, post distress period. This former finding is in line with that of

Sudarsanam and Lai (2001). They find that a higher proportion of the recovered

companies undertake dividend cuts/omissions in the two years following a year of

negative z-score. The sample of companies identified as financially-distressed by the

aforementioned study, suffers from more severe form of financial distress and in this

case we have discovered that our companies suffer from protracted performance

decline which is serious, but, perhaps not so severe as evidenced by the fact that

these companies carry on surviving (of course, we have only included companies

with 3 years post distress information in this sample creating survival bias in the first

place, but nevertheless, these companies exhibit distress, undertake measures to

rectify them and carry on living).

Whilst agreeing in principle with Sudarsanam and Lai (2001) that dividend

cuts and omissions are merely contributory survival measures, one would argue that

these are very important immediate steps a faltering company needs to undertake in

order to improve its chances of recovery along with other cash generating and

conserving methods. One also sees that, the coefficient signs for the cash conserving

variables, namely, dividend cuts and omissions are positive. On the other hand, the

two cash generating strategies (from financial restructuring) namely rights issue and

raising debts have negative and positive signs respectively.

It has been also seen earlier that, recovered and non-recovered do not differ

so much in terms of cash generation but do differ in terms of cash conservation.

Moreover, the results suggest is that, raising more cash in form of debt in the distress

period increases the chances of recovery whilst raising cash in the form of equity

issue does not. Given that our sample of companies do not have huge debts to begin

with, raising debt would seem like an immediate option and the negative sign of

rights issue and the positive sign of raising debt also validate the Pecking Order

theory. When we introduce just the financial restructuring variables in the logit

regression to explain recovery/non-recovery, the significant variables are dividend

cuts, omissions and raising all positive and highly significant. Rights issue and debt

refinance are not significant in this case.


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MBOs/Spin-offs and Change of business are not significant asset

restructuring activities. Acquisitions are significant (at 5%) and have negative

coefficient whilst Disposals are highly significant (at 1%) and bear a positive sign.

This implies that, lesser acquisitions in the distress period have a greater chance of

recovery. In other words, organic growth in the distress period and not growth by

acquisition increases the chances of recovery. Disposal of non-core businesses and

assets (retrenching) is positive implying higher the retrenching, higher the chances of

recovery. Acquisitions, a cash depleting measure has a negative coefficient.

Therefore, higher levels of acquisition in the distress period increase the chances of

non-recovery in our sample. Slatter (1984, pg. 96) states that companies with poor

financial performance but not yet in severe distress often undertake acquisitions to

accelerate growth. But these need to be selected and managed carefully to achieve

and sustain successful turnaround according to Grinyer et al (1988, pg. 98). When

only asset restructuring variables are regressed as independent variables to explain

recovery/ non-recovery, we find that acquisition is negative and highly significant,

Disposals are positive and highly significant whilst Change in Business is negative

and significant at 5%.

In case of management restructuring the significant strategies are Insider

Appointment (negative and significant at 1%), Insider replacement negative and

significant at 5% and Outsider replacement positive and significant at 5%. This

implies that increased fresh perspectives and new ideas coming from outsiders

translate into recovery. According to Nystrom & Starbuck (1984) and Slatter and

Lovett (1999), in companies facing performance decline, the turnaround process is

usually set in motion with the removal of top managers. Barker et al, (2001) study

organisational causes and the strategic consequences of the extent of top

management team replacement in the turnaround context, and suggest that,

replacements, especially outsider replacements are likely to have new outlook and

fresher perspectives given their differing knowledge and experience. When

recovery/non-recovery is regressed on by only board change variables, we find that

only insider appointments are significant (at 1%) and bear the negative sign. None of

the other board change variables are significant. This implies that insider

appointments do affect recovery negatively and fresh blood is required to ensure

recovery. In summary therefore, we find that the recovery is explained by cash

generating or cash conserving strategies as opposed to cash depleting strategies.


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Monetary impact of strategies undertaken

In this section, we discuss the observable changes in the recovered and non-

recovered companies, in line with the John et al (1992) paper. We focus on the core

changes that the recovered and non-recovered sets of companies go through in

monetary terms given their financial situations. The companies in our sample, it has

been seen before, carry on undertaking different restructuring measures in the post

distress period too with the recovered companies focussing more on asset

restructuring and the non-recovered being rather unfocussed. According to Martin

Arnold, Private Equity Correspondent at the FT, Speed is critical in turnaroundsituations, as negotiations with banks, customers, suppliers, the taxman and others

can be distracting for the management and damaging for the business. Similar theory

is also advocated by Weiss and Wruck (1998). The most relevant period to observe

any change in the financial variables of the sample companies therefore would be the

period from year T0 to T+1. Whilst we discuss this immediate post distress period in

the following sections, we discuss the other periods too and provide an overall

change from T0 to T+3 in the each case. However, once again the only period of

interest in this case is the immediate post distress period for this part of the analysis.

Table 6 presents the results. In line with the John et al (1992) study, we

measure changes in the size of a company in terms of percentage change in total

assets, sales and employment. Therefore, year T+1 change reflects the change from

T0 to T+1 and so on. The results show that there is no significant change for the

recovered companies from year 0 to 1. Along the lines of the said paper, we find

that, total assets increase significantly from year 1 to 2 (6%) and from year 2 to 3

(6%) for the recovered set of companies. In case of non-recovered companies, there

is a significant decline in TA from year 0 to year 1 (-7%) and there is no significant

change in total assets from year 1 to 2, but there is a significant decline from year 2

to year 3 (-9%). Increase in TA in this case, can be considered as an asset

restructuring measure, given that it has been seen from the news releases, majority of

the companies are increasing focus and retrenching, asset growth can be considered

as vertical integration. This also implies that, while in the distress period, the

recovered companies are more inclined to cash generating and cash conserving


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measures in the post distress period they are focussed more on expansionary

measures.

Similarly, the recovered company sales growth is not statistically significant

in the period from year 0 to 1 (though the figure is an improvement over the previous

years change), but show a significant increase from year 1 to 2 (13%) with a slight

fall from year 2 to 3 though remaining positive at 10%. However, in case of non-

recovered companies, sales fall in year 0 to 1 (not significant) and there is no change

in sales from year 1 to 2, but there is a significant rise in sales from year 2 to 3 (5%).

John et al (1992) study 46 large companies and find that their sample of companies

that face performance decline show a median increase in assets (3.6% from year 0 to

3) and sales (8.54% - from year 0 to 3).

The sample used by John et al (1992) is by definition a recovered sample

since they use companies which have a years negative income followed by at least 3

years of positive earnings. The corresponding findings are Total Assets increase by

16% and Sales increase by 21% from year 0 to 3 (significant at 1%). These are

higher numbers as compared to those found by John et al (1992), but mostly because

the samples and sample periods differ, as also the fact that the figures are not

adjusted for inflation. However, in line with the said paper, despite facing

performance decline, recovered companies do not reduce their scale of operations as

opposed to the non-recovered companies.

Employment for the recovered companies falls significantly from year 0 to 1

and then increases significantly from year 1 to 2 and remains the same from year 2 to

3 as opposed to the non-recovered companies which have no change in employment

at all. Thus it can be seen that employment reduction (in line with the findings of

John et al (1992) is done rapidly after the period of negative earnings in case ofrecovered companies. Bhagat et al (1990) found employment cuts of 5.7% in the

aftermath of successful hostile takeovers and we find that in the immediate post

distress period, the employment cut in our case was slightly higher at 8%.


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Panel B of Table 6 reports the results for changes in investments and

financing characteristics. In addition to the cost of goods sold and labour costs

used in the John et al study (1992), we use changes in selling, general and

administrative expenses, staff and wages (labour) costs to proxy for changes in

costs. Year 0 to 1 shows significant fall in the cost of good sold (-4%), selling,

general and administrative costs (-9%), staff costs (-6%) and labour costs (-6%)

for the recovered companies. In contrast, the year 0 to 1 for the non-recovered

companies shows no significant change in any of the cost measures. Rapid cost

cuts are thus introduced by recovered set of companies as opposed to the non-

recovered companies. In the period from year 1 to 2, recovered companies show

an increase in the SGA costs which is significant and non-recovered companies

show significant rise both in the SGA and labour costs (at 10% level). From year

2 to 3 non-recovered companies show a fall in labour costs. Overall, it seems

like the non-recovered companies do not incorporate rapid costs cuts as

compared to their recovered counterparts.

John et al (1992) report that in the short run the recovered companies

reduced their costs and from year 0 to year 3 median COGS/Sales fell by 1.63%

and median labour costs/Sales fell by 4.24% our commensurate figures are -5%

and -10% respectively. Again in line with their paper, we find that the

companies that recovered cut costs rapidly and immediately. Overall, from year

T0 to year T+3 it is seen that the recovered companies show significant and

quick costs cuts in all the cost categories whilst in case of the non-recovered

companies none of the median cost changes are statistically different from zero.

In case of the non-recovered companies, the sales do not show

improvement, irrespective of the costs cuts and reduced labour forces. In this

case, reducing costs without increased revenues translates into inefficiency. Inthe immediate post distress period, recovered companies show increased sales

(not significant) and non-recovered companies show falling sales (not

significant) and on the whole whilst both the recovered and non-recovered

companies show increased sales and falling employment, the higher proportion

of these in case of the recovered companies point towards higher degree of

efficiency.

In case of investments characteristics, we digress from the John et al (1992)

study. They use investments in R&D and Advertising as proxies for investments.


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Whilst these are not entirely incorrect, R&D expenses predominantly figure in

pharmaceutical and related industry and advertising though omnipresent is much

more prevalent in the service industry. Given the different industries included in our

sample, we therefore use capital expenditure to proxy for investments. We present

both scaled and un-scaled measures for robustness checks. Capital expenditure rises

from year 0 to 1 and rises even further in year 1 to 2 in case of the recovered

companies. In case of non-recovered companies, the capital expenditure falls from

year 0 to 1 (though not significant) and then rises in year 1 to 2. At 15% it is however

half as compared to the capital expenditure made by the recovered companies at

30%. In the period from year 2 to 3, there is a slight fall in case of capital

expenditure in case of the recovered companies which is still significant and positive.

In the commensurate case of the non-recovered companies, we find that the capital

expenditure falls and is not significant.

Capital expenditure scaled by Total assets for the recovered companies show

significant increase in the period from 0 to 1 and from 1 to 2 with a slight fall in year

2 to 3 though remaining positive. This is in contrast to the non-recovered companies

which have a fall in year 0 to 1 (not statistically significant) followed by a rise once

again not statistically significant and then in the period from year 2 to 3 they have

show a fall which is significant at 10%. Capital expenditure, according Schendel et

al (1976) and Hambrick and Schecter (1983) is usually designed to achieve

efficiency/productivity improvement, for instance building/acquiring new plants

and/or equipment. Sudarsanam and Lai (2001) point out that since such expenditure

involves cash outflow, firms in decline can only undertake it so long as it ensures and

promotes their recovery. They also state that such expenditure complements rather

than conflicts with efficiency driven operational restructuring. We find that, in the

immediate post distress period the recovered companies show a significant increase

in capital expenditure whilst the non-recovered companies show a fall (though not

significant). In fact, in the overall post distress period the non-recovered companies

show only a very small increase in capital expenditure as opposed to the recovered,

who seem to undertake such expenditure at full throttle.

Andrade and Kaplan (1998) report that the highly leveraged companies in

their sample that do not suffer adverse economic shock show an increased capital

expenditure /sales ratio of 9.4% in the post resolution period (first year after distressresolution) as compared to the -13.4% in the pre resolution period. Overall, from T0


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to T+3, the capital expenditure investments by the recovered companies at 57% are

much higher than those made by the non-recovered companies at 5%. When scaled

by TA, the capital expenditure for recovered companies is a 33% increase

(significant at 1%) overall from year T0 to T+3 and -10% (not significant) fall for

non-recovered companies.

Working capital for both the recovered and non-recovered companies falls in

the period from year 0 to 1 with non-recovered companies falling much more as

compared to recovered companies. The fall implies an increase of trade creditors,

accruals, other creditors, cash in advance etc. or a fall in raw material stocks, work in

progress, finished goods stocks, trade debtors, other debtors, prepayments etc. In the

year from 1 to 2, recovered companies show increase in working capital as opposed

to non-recovered companies. Finally, from year 2 to 3 we see that, working capitalfor both the sets drops significantly, once again with non-recovered companies

falling much more at -36% as compared to the recovered at -11%. This implies that

the recovered companies build up their stocks, renegotiate with suppliers etc. much

more rapidly as compared to the non-recovered companies. Non-recovered

companies seem to be unable to build up stocks and show heavy depletion and/or

seem to be unable to re-negotiate terms with suppliers. This is intuitive in many

ways, since suppliers would be unwilling to extend credit terms to a company facing

decline. Perhaps, the fact that the non-recovered companies do not spend much on

capital expenditure as opposed to the recovered companies, also affects the

inventory.

Asset liquidity allows managers to counter the problem of immediate cash

flow by allowing them extra room for raising additional liquidity to meet short term

obligations. Managers of companies with highly liquid asset structures would

therefore be more inclined to liquidate their working capital (liquid assets) thereby

postponing the inevitable decline. Managers also indulge in systematic asset

stripping as documented by Weiss and Wruck (1998) which once again proves to be

a very expensive endeavour for the creditors. This is apparent from the earlier

finding that the non-recovered companies show significant falls in their total assets.

On the whole, from T0 to T+3, the working capital fall at -59% (significant at 1%) is

much greater for the non-recovered companies as opposed to the recovered

companies at -28% (significant at 10%). Altman (2000) describes WorkingCapital/Total Assets as the net liquid assets of a company relative to the total


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capitalisation. This ratio forms the first variable in the z-score model and a negative

sign indicates liquidity problems. The high cash piles in case of the non-recovered

companies and yet a very low Working Capital /Total Assets ratio implies depleting

inventory, falling receivables etc. which once again points towards longer and

perhaps unhealthy credit terms or could mean that the non-recovered companies are

squeezing out whatever they can to free cash.

In terms of changes in financial policies, in line with the John et al (1992)

study, we report the percentage change in the Debt to total asset ratio along with

percentage change in actual dividends paid. Along with these we also report on

changes in Cash scaled by TA. In line with John et al (1992), we find that, the

recovered companies cut their debt levels rapidly and immediately. Dividends show

a significant fall in case of the recovered companies from year 0 to 1. From year 1 to2 there is a significant rise in dividends and this falls but remains positive from year

2 to 3. In case of the non-recovered companies, the fall in dividends (-62%) is much

higher than those of the recovered companies (-21%) in year 0 to 1. In year 1 to 2,

the dividends carry on falling but not as much in the pervious time period. So, some

non-recovered also resume their dividend payments. In the final period, however the

dividends once again fall considerably. On the whole, the recovered companies show

a significant rise in dividends from year T0 to T+3 as opposed the non-recovered

companies which show a significant fall of almost 100%.

Cash scaled by total assets rises significantly for the recovered companies in

year 0 to 1 and from year 1 to 2. In case of non-recovered companies, cash rises

considerably and significantly in year 0 to 1 and then fall significantly in the period

from year 1 to 2. This could be due to initial sales of business and surplus assets

(manifest from falling total assets) followed by increased acquisitions. It falls even

further in the period from year 2 to 3 in case of the non-recovered companies. Cash

for the recovered companies also falls during this final period, but is not significant.

On the whole, both recovered and non-recovered companies show significant

increase in cash but in case of the non-recovered companies the increase is a 32% as

opposed to the 1% increase in case of the recovered companies.

Interestingly, the ratio of debt to total assets decreases by 18% in case of

recovered companies in the period from year 0 to 1. Non-recovered companies show

a fall too but this is not significant. In all other following periods, there is no


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significant change in debt in either set of companies. The same pattern is followed

when we look at percentage change in debt itself (not scaled by total assets).

Recovered companies therefore cut their debts rapidly as opposed their non-

recovered counterparts. On the whole, it is again interesting to see that the recovered

companies show a significant fall of 30% as compared to a negligible and

insignificant fall in case of the non-recovered companies. Immediate reduction in

dividends and increase in cash is manifest in both the sets of companies. Given that

the non-recovered companies carry on making losses in the post distress period, most

of them do not pay dividends which explains the fall in dividends. The increased

cash levels in case of non-recovered companies combined with falling total assets,

low capital expenditure and greater fall in working cap implies that the companies

are undertaking assets sales and generating cash.

However, the use of the cash pile is questionable since the levels of debts do

not fall nor does the level of dividends paid out increases. This implies that the cash

is retained within the company to help undertake new recovery measures. It therefore

needs to be acknowledged that it is not simply cash generation that will aid recovery

but it is also the use of such cash. However this does not diminish the importance of

generating cash. Moreover, as seen in Table 3 above, both the recovered and non-

recovered companies adopt similar proportions of cash generating strategies. This

finding combined with the large cash piles of non-recovered companies mostly

points towards retention of cash in the non- recovered company. It is also seen that

cash generating and conserving variables in the distress period are associated with

recovery. When all these findings are out together, one can see that the combination

of cash generating and conserving strategies during the distress period guide a

company towards recovery.


In sum, our results indicate that, in line with our expectations, the recovered

companies are more active in cash generating and cash conserving restructuring as

opposed to any other restructurings in the distress period. Also, more number of

recovered companies is active in financial restructuring (7 out of 8 possible financial

restructuring activities are related to either generating or conserving cash) in the

distress period as compared to the non-recovered companies. The intensity of the

restructuring in the distressed period also points towards financial restructuring in


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case of the recovered companies. In case of the non-recovered sub sample, we see

that, the focus is more on operational and not financial. In the post distress period

too, the non-recovered companies show a distinct lack of focus in implementation of

the strategies. Moreover, the regression results of show that 4 out of the 8 financial

restructuring variables (each of which is either cash generating or cash conserving)

are significant in explaining recovery as compared to 2 (one cash generating and one

cash depleting) of the 7 asset, 1 (cash conserving) of the 3 operational and 3 of the 4

board restructuring variables included in the model.

Given that the companies undertake cash generating and cash conserving

strategies, we also examine the effects of such strategies on the post distress financial

variables in line with the John et al (1992) study. Our findings confirm their findings,

in that, the recovered companies implement immediate and rapid cost cuts, conserveand raise cash in conjunction with increased capital expenditure whilst increasing

their sales and assets in the short run. Summarising the above findings, we find

support for our hypothesis that after controlling for size, industry, time, cost and

efficiency factors, companies that recover are likely to adopt more financial

strategies than the companies that did not; and that these strategies are more likely to

be cash generating or cash conserving strategies.

5. Conclusions

In line with Sudarsanam and Lai (2001), we find that, our sample of

recovered and non-recovered companies adopts similar strategies on the onset of

losses but non-recovered companies are more sluggish in implementation in the

beginning. They also differ from the recovered companies, in that they undertake

operational restructuring more aggressively as opposed to financial restructuring as

in seen in the case of recovered companies. In other words, we find that companiesthat recover tend to undertake higher proportion of financial strategies as opposed to

non-recovered companies providing corroborating evidence for our first

hypothesis. We also see that, in the immediate post distress period, recovered

companies show significant cost cuts and non-recovered companies do not. This

implies that the recovered companies are more effective when it comes to

implementation.

We also find that, whilst both sets of companies undertake similar

proportions of cash generating strategies companies that recover undertake a higher


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proportion of cash conserving strategies; this implies that recovered companies are

more efficient and tighter in their monetary policies while the non-recovered

companies burn cash more easily. Therefore, we find corroborating evidence for our

second hypothesis which states that companies that recover are more likely to

undertake cash generating or cash conserving strategies. In line with Zimmerman

(1989), we find that the recovered companies were also successful because they

maintained their low costs, unlike the unsuccessful companies who tried to increase

revenue by selling into new markets or acquiring other companies. The recovered

sub-sample seems to be more diligent and disciplined in the implementation of cost

reduction programs. In other words, to quote Zimmerman, we find that our

recovered companies tended to have a flair for handling money conservatively, and

they also spend less on selling, general and administrative and other expenses.

It is seen, from all of the above that, recovery of a company is not a function

of one particular strategy but is a combination of varying degrees of all of the 4 main

restructuring activities. The recovered companies cut costs, generate and conserve

cash, bring in outside management people on its board, increase capital expenditure

whilst, non-recovered companies do the same but have far lower degrees of stringent

implementation in each of these activities. Moreover, given that the non-recovered

companies stay in the red in the post distress period, they are more unfocussed in the

post distress period giving importance to different strategies in each of the three

years. In the post distress period, the recovered companies consistently prioritise

operational efficiencies and forward looking expansionary measures while the non-

recovered companies are still trying out different means to recover. The lack of

focus, the varying intensity in implementation, the inability to decrease cash burn (as

compared to the recovered companies) costs the non-recovered companies dearly. In

the post distress period, we find that the non-recovered companies also prioritise

asset restructuring (forward looking and expansionary measures), but, once again it is

ridden with lack of focus. Whilst causality cannot be argued, one does see that

despite adopting similar measures the non-recovered carry on being non-recovered. It

would be interesting to study how companies in a specific industry or a specific

period react to similar type of distress and whether changing the definition of distress

itself, could indicate differences in the results.


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Table 2: Period wise distribution of restructuring news releases

This table presents an overview of the news releases for both the recovered and non-recovered companies. Thistable presents the number of news releases in each of the periods for the 258 companies. The total number ofnews releases is 8503, comprising of 4059 news releases made by 123 recovered companies and 4444 news

releases made by 135 non-recovered companies. The figures in the brackets are percentages (in each period).Therefore, in T-2, of all the 4 restructuring announcements made by the recovered companies, Operational

restructuring forms 5% and so on. T-2 is the first year of loss, T-1 is the 2 consecutive year of loss, T0 is the thirdconsecutive year of loss, T+1 is the first year after three consecutive losses and so on. Panel present the newsreleases for recovered companies, Panel B for Non-recovered companies and Panel C gives the z statistic. ***, **

and * are significant at 1%, 5% and 10% respectively.

Panel A - 123 Recovered Companies

Recovered Companies T-2 T-1 T0 T+1 T+2 T+3

Operational Restructuring 41 (5%) 30 (3%) 23 (3%) 30 (4%) 42 (10%) 28 (7%)

Financial Restructuring 248 (30%) 285 (32%) 242 (30%) 220 (31%) 196 (45%) 145 (36%)

Asset Restructuring 28 (3%) 33 (4%) 65 (8%) 64 (9%) 42 (10%) 52 (13%)

Board Restructuring 56 (7%) 45 (5%) 35 (4%) 19 (3%) 27 (6%) 21 (5%)

Others 451 (55%) 486 (55%) 441 (55%) 378 (53%) 128 (29%) 158 (39%)

Periodic Total 824 879 806 711 435 404

Panel B - 134 Non-recovered Companies

Non-recovered

CompaniesT-2 T-1 T0 T+1 T+2 T+3

Operational Restructuring 49 (4%) 15 (2%) 16 (2%) 7 (1%) 10 (2%) 6 (2%)

Financial Restructuring 289 (25%) 251 (27%) 274 (28%) 239 (38%) 193 (37%) 112 (42%)

Asset Restructuring 63 (6%) 33 (4%) 52 (5%) 23 (4%) 14 (3%) 5 (2%)

Board Restructuring 80 (7%) 78 (8%) 68 (7%) 38 (6%) 33 (6%) 11 (4%)

Others 657 (58%) 541 (59%) 568 (58%) 315 (51%) 272 (52%) 132 (50%)

Periodic Total 1138 918 978 622 522 266

Panel C - Proportion test

Restructuring Total

Recovered Non-recovered z stat

Operational Restructuring 194 103 6.18***

Financial Restructuring 1336 1358 2.33**

Asset Restructuring 284 190 5.46***

Board Restructuring 203 308 -3.74***

Others 2042 2485 -5.18***


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Table 3: Differences in proportion of the strategies undertaken by the financially distressed

companies during the distress period

Panel A presents the proportion statistics for the generic restructuring strategies whilst Panel B presents the cash

based strategies. The figures in the brackets are the number of recovered and non-recovered companiesrespectively. ***, ** and * are significant at 1%, 5% and 10% respectively.

Distress Period Recovered (123) Non-Recovered (135) z-stat

Panel A: Differences in types of strategies

Operational Restructuring 11% 15% -1.215

Financial Restructuring 68%*** 47% 4.875

Asset Restructuring 13%*** 23% -2.918

Board Restructuring 8%*** 15% -2.703

Panel B: Differences in cash strategies

Cash Generating Strategies 37% 36% 0.214

Cash Conserving Strategies 49%*** 32% 4.13

Cash Depleting Strategies 5%*** 15% -3.76

Total Cash Generating and CashConserving

86%*** 68% 4.96

Panel C. Median Differences in fundamentals (last column Mann Whitney p-value)

Total Assets m 23*** 10 0.00

Return on Assets -0.04*** -0.10 0.00

Leverage 0.30** 0.27 0.05

Cost of Goods Sold/ Sales 0.77 0.74 0.16


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Table 4: Correlation matrix of strategies

This matrix shows the pair wise correlation between the strategy variables. The dependent variable is recovered =1 and non-recovered =0; Ratl. is rationalisation, Intgr. is integration, Appts. is appointments and

Repl. is replacements.

StrategiesCost

Ratl.Layoffs

Intgr. of

Business

Dividend

Cuts

Dividend

Omissions

Rights

Issue

Raise

DebtAcquisition Disposal

MBO Spin-

offs

Business

Change

Insider

Appts.

Outsider

Appts.

Insider

Repl.

Outsider

Repl.

Cost

Rationalisation1

Layoffs 0.4 1

Integration of

Business0.23 0.2 1

Dividend Cuts 0.08 0.07 0.15 1

Dividend

Omissions0.22 0.17 0.13 0.22 1

Rights Issue 0.04 -0.05 0.08 -0.12 0.03 1

Raise Debt 0.24 0.16 0.12 -0.05 0.08 0.07 1

Acquisition 0.1 0.14 -0.05 -0.12 -0.07 0.12 0.15 1

Disposal 0.4 0.32 0.16 0.05 0.13 0.04 -0.01 0.39 1

MBO Spin-offs 0.16 0.14 -0.02 0.02 0.06 0.05 0.19 0.08 0.17 1

Business Change 0.2 0.29 -0.03 0.07 0.01 -0.05 -0.03 0.17 0.42 0.2 1

InsiderAppointments

0.24 0.1 0.08 -0.02 0.08 0 -0.04 0.19 0.25 0.13 0.17 1

Outsider

Appointments0.24 0.37 0.17 -0.05 0.07 -0.01 0.04 0.25 0.34 -0.03 0.05 0.28 1

Insider

Replacements0.38 0.26 0.08 0.02 0.12 0.07 0.15 -0.03 0.2 0.13 0.17 0.09 0.14 1

Outsider

Replacements0.19 0.08 0.06 -0.02 0.09 0.17 0.21 0.38 0.42 0.11 0.05 0.27 0.23 0.27 1


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Table 5: Logit regression of the main cash related strategies

This table presents the logit regression output. The regression is pooled over the distress period. The dependentvariable is recovered =1 and non-recovered =0; Control variables are, Industry dummies, Size dummies, Yeardummies, Efficiency is Sales/Total Assets and Costs is Cost of Goods Sold/Sales. ***, ** and * are significant at

1%,

corporate distress

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