provision of management incentives in bankrupt firmsconference/conference2012/... · that retention...
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Provision of Management Incentives in BankruptFirms∗
Vidhan K. Goyal† Wei Wang‡
October 27, 2012
Abstract
We examine the use of key employee retention plans (KERPs) in bankrupt firms.We find that creditor control of bankruptcies is associated with a greater likelihoodof bankrupt firms offering retention and incentive bonuses to managers. Retentionbonus plans are also more common when there is a greater risk of employee turnover.We find that incentives provided under such plans improve bankruptcy outcomesfor creditors along several dimensions: they increase the likelihood of emergence,reduce bankruptcy duration, and result in fewer violations of the absolute priorityrule. Our results do not support the common view that retention bonus plans enrichmanagers at the expense of creditors.
JEL classification: G30, G32
Keywords: Key employee retention plans; KERP; Chapter 11; compensation; re-tention bonuses; creditor control; incentive bonuses
∗We acknowledge the helpful comments of Wei Jiang, Ken Lehn, Frank Li, Angie Low, Adair Morse,Paul Oyer, Jano Zabojnik and workshop participants at Concordia University, Hong Kong University,Monash University, Nanyang Technological University, National Chengchi University, Queen’s University,Singapore Management University, Yuan Ze University, and conference participants at the 2012 NorthernFinance Association annual meetings and the Seventh Annual Conference on Empirical Legal Studies atStanford Law School. We thank Wenhan Lin, Matt Murphy, Remya Neela, and Nikhil Wadhwa forexcellent research assistance, and Lynn LoPucki, Parcels Inc., and National Archives at various locationsfor their help with data collection. Vidhan Goyal thanks the Research Grants Council for financialsupport (RGC Project #641110). Wei Wang thanks the CA Queen’s Center for Governance for financialsupport. c© 2012 by Vidhan K. Goyal and Wei Wang. All rights reserved.†The Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong,
E-mail: [email protected]‡Queen’s School of Business, Queen’s University, Kingston, Ontario, Canada, K7L 3N6, E-mail:
“The bankruptcy court has become a place where corporate executives go toget permission to line their pockets and break their promise to workers andretirees.”
– Senator Edward Kennedy1
1 Introduction
Bankrupt firms often pay retention and incentive bonuses to their key employees to per-
suade them to stay with the firm through the restructuring process. Worldcom Inc., for
example, filed for bankruptcy in July 2002 and offered 329 of its key employees retention
bonuses that paid between 35% to 65% of their annual salary. Half of this bonus was paid
if the employees under the plan remained with the company for at least 5 months. The
remaining amount was payable 60 days after confirming a plan of reorganization.
Retention bonus plans are commonly viewed as schemes through which managers
enrich themselves. Critics claim that retention bonuses reward failed and entrenched
managers. For example, testifying before the U.S. Senate Committee on the Judiciary,
David McCall, a director with the United Steel Workers of America, characterized reten-
tion bonuses as corporate abuse and argued that KERPs are “golden parachutes payable
to executives of a reorganizing company and rewarding them handsomely, often after they
have cut workers’ pay reduced or eliminated retiree benefits, shuttered plants, and sold
them off . . . When workers learn of a KERP or massive fee award [paid to professionals],
it puts our bankruptcy system in a bad light and often makes the difficult choices required
in bankruptcy even harder to achieve.”2
1Statement of Senator Edward Kennedy to U.S. Congress (151 Congress Record S1990, March 3,2005). Congress eventually introduced provisions in the ‘Bankruptcy Abuse Prevention and ConsumerProtection Act of 2005’ (BAPCPA), provisions which made it difficult for companies in Chapter 11 topay retention bonuses.
2Statement of David McCall to the Senate Committee on the Judiciary on “Bankruptcy Reform” onFebruary 10, 2005. Media has also taken a negative view on retention bonus. See, for example, “Want
1
Defending these bonuses, companies have taken the position that retention plans pre-
vent critical employees from leaving when they are most needed. Management departures
in distressed firms are very common. Such departures are highly disruptive to the success-
ful and expeditious resolution of bankruptcy, as they result in a loss of continuity and high
search and training costs. As a result, the costs incurred through delays in bankruptcy
resolution and management changes could often be far greater than the cost of “pay-to-
stay” bonuses to key employees. According to firms using these plans, retention bonuses
are an efficient contracting solution to the problem of high turnover in bankrupt firms.
To examine the two starkly different views – the rent extraction view and the efficient
contracting view – we assembled a comprehensive database of key employee retention
plans (KERPs) at large public firms that filed for Chapter 11 between 1996-2007. This
database provides us with a first detailed look at the structure of retention and incentive
bonus plans in bankrupt firms.
Of the 417 firms in the sample, 39% adopt KERPs. Most plans offer retention bonuses
tied to a minimum stay of, on average, 9 months. The plans cover about 2% of the
firm’s employees and pay bonuses that are between 30 and 70% of their base salaries.
About half of these plans offer additional incentives tied to the resolution of bankruptcy
(either through emergence from bankruptcy or sale of assets), speed of restructuring,
debt recovery, and specific targets based on financial performance at plan confirmation.3
Some Extra Cash? File for Chapter 11 - ‘Pay to Stay’ Bonuses Are Common at Busted Tech Firms” byAnn Davis in the Wall Street Journal, October 31, 2001; “Bankruptcy-Law Overhaul Has Wriggle Room- Limits Set on Key Executives’ Pay, But Door Is Wide Open on Bonuses Linked to Achieving CertainGoals” by Nathan Koppel and Paul Davies in the Wall Street Journal, March 27, 2006; “$8.9M for Brass;Zip for Laid-off Staff - Canwest Secures Bonuses for Top Officials Despite Bankruptcy Filing” by MartinCash in the Winnipeg Free Press, October 24, 2009; “The CEO Bankruptcy Bonus” by Mike Spectorand Tom McGinty in the Wall Street Journal, January 27, 2012; “Testing Chapter 11 Limits” by RachelFeintzeig and Jacqueline Palank in the Wall Street Journal, August 19, 2012.
3The passage of BAPCPA in 2005 led to a precipitous decline in retention bonus plans and many firmscompletely switched to offering incentive bonus plans.
2
A reading of these plans suggests that incentives provided by bankrupt firms closely tie
bonuses to creditors’ claims and bankruptcy outcomes.
One of the key findings of our paper is that retention and incentive bonuses are common
in bankrupt firms that exhibit a large amount of creditor control. Specifically, bankrupt
firms with an approved creditors committee and with debtor-in-possession financing more
often pay retention and incentive bonuses. This evidence is consistent with senior-secured
lenders exerting control over bonus plans through loan documents in debtor-in-possession
financing while other unsecured lenders acting through a creditors’ committee.4
KERPs are also more common among bankruptcies in which there is a greater like-
lihood of employee turnover. Employees are more likely to change jobs when there are
many other potential employers in the same industry located in the same geographical
area as the Chapter 11 firm. We find that KERPs are more frequently adopted by firms
headquartered in such areas. In addition, KERPs are more frequently observed in in-
dustries in which senior executives benefit from greater growth in cash compensation. In
such industries, KERPs reduce the threat of employee turnover resulting from large pay
disparities at the bankrupt firm. Finally, firms in distressed industries exhibit a lower
likelihood of adopting these bonus plans presumably because there are fewer outside job
opportunities in such industries.
The only CEO characteristic that appears to be important in explaining CEO partic-
ipation in bonus plans is whether or not the CEO is a newly-hired turnaround specialist.
Such CEOs are more frequently paid retention bonuses. None of the other CEO charac-
teristics appears to matter. Moreover, governance variables have no predictive ability in
4Similarly, Eckbo et al. (2012) show that creditors are actively involved in CEO replacement decisionsand in designing the compensation of existing and new CEOs.
3
determining CEO participation in these bonus plans. Overall, there is no evidence that
“entrenched” CEOs initiate these plans to pay themselves large bonuses.
We further examine the effect of KERPs on bankruptcy outcomes. We distinguish
between KERPs that are retention-only plans from those that provide incentive bonuses
(with or without retention bonuses). The retention-only plans pay bonuses contingent on
a minimum stay or stay until plan confirmation and do not include an incentive component
tied to specific outcomes. In our tests, we use employees’ outside job options to identify
exogenous variation in the use of bonus plans.
While retention-only bonus plans do not materially improve outcomes for creditors,
KERPs that include incentive bonuses significantly improve outcomes. The likelihood
of a firm’s emergence from bankruptcy is greater when key employees are paid incentive
bonuses. Importantly, the outcome depends on the specific nature of incentives in these
plans. When key employees are offered bonuses that are tied to firm reorganization or
firm performance upon reorganization, firms are more likely to reorganize. By contrast,
when employees are paid bonuses tied to asset sale, firms are more likely to liquidate.
Furthermore, incentive bonuses affect both the duration of bankruptcy and deviations
from the absolute priority rule (APR). Firms that provide incentive bonuses spend sig-
nificantly less time in bankruptcy and exhibit a significantly lower likelihood of deviating
from the APR. This last result shows that provisions of incentive bonuses significantly
reduced shareholders’ ability to extract concessions from creditors. Overall, the findings
suggest that incentive plans improve outcomes for creditors by aligning managers’ inter-
ests with those of creditors, shortening bankruptcy duration, and limiting stockholders’
ability to extract concessions from creditors.
4
Relative to KERPs, standard compensation contracts are less relevant, perhaps even
suboptimal, when the fiduciary obligations of managers shift towards creditors as creditors
take control of the bankruptcy process. The results of the paper show that incentives
provided to executives of bankrupt firms become more closely aligned with the interests
of creditors. More broadly, the paper examines whether managers control the pay-setting
process in bankrupt firms, where agency problems are likely to be more severe. We
find no evidence consistent with the rent extraction view. In fact, our results suggest
that retention and incentive bonuses in bankrupt firms are the outcome of an optimal
contracting process. Finally, the fact that bankrupt firms provide retention and incentive
bonuses to key employees at all levels of corporate hierarchy suggests that the restructuring
of troubled companies requires more decentralized decision-making.
The paper is organized as follows. Section 2 provides a review of the literature on
CEO compensation in bankrupt firms and a review of our hypotheses. Section 3 describes
our data sources and the construction of key variables, and provides a summary of the
key features of retention and incentive bonus plans. Section 4 employs logit regressions to
predict the use of KERPs in bankrupt firms. Section 5 provides results from regressions
that examine the effect of KERPs on bankruptcy outcomes. Section 6 concludes the
paper.
2 Background
In a standard principal-agent framework, firms design compensation contracts to align the
interests of managers with those of stockholders. However, when firms become insolvent,
the fiduciary duties of managers shift from stockholders to creditors. How do incentive
structures evolve for firms in distress? What determines the payment of retention bonuses
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in bankruptcies? How do bonus payments affect bankruptcy outcomes? This paper
explores these questions.
Much of what we know about the compensation of managers in distressed firms comes
from Gilson and Vetsuypens (1993), who examine the compensation policies of 77 publicly-
traded firms that filed for bankruptcy or privately restructured their debt between 1981
and 1987. Gilson and Vetsuypens found that CEOs in these firms suffer large personal
losses. Importantly, their results highlight the fact that firms often rely on compensation
policy to deal with financial distress. About 20% of firms in Gilson and Vetsuypens’ sam-
ple based their CEO’s compensation on the outcome of the firm’s financial restructuring.
In about 17% of the cases, bonuses were tied to a minimum length of stay with the firm,
and in another 10% of the cases, compensation plans were restructured to increase the
interdependence of the wealth of the CEO and that of creditors.
Two relatively recent papers also examine the compensation of CEOs in bankruptcy.
Henderson (2007) examines 76 large bankruptcies between 1992-2003 and finds that the
compensation of CEOs does not significantly change during distress situations. On the
contrary, Kang and Mitnik (2009) examine 99 bankruptcies over the 1992 to 2005 period
and arrive at the opposite conclusion. Specifically, they find that the CEOs of distressed
firms experience a significant reduction in their overall compensation, and that much of
this reduction is due to the decreased value of new grants of stock options.
This paper is unique in that it examines the retention and incentive bonus payments
offered to a larger group of employees identified as critical or key employees. The payment
of bonuses to key employees via KERPs grew in popularity in the early 2000s. Skeel (2003)
and Ayotte and Morrison (2009) argue that the increasing trend in the use of KERPs in
bankruptcies coincides with greater creditor control. Creditors are becoming increasingly
active in bankruptcies and are often instrumental in CEO replacement decisions and in
6
determining the design and structure of senior executives’ compensation. Eckbo et al.
(2012) find that creditor control is directly responsible for CEOs’ personal losses from
bankruptcy.
The changing nature of the bankruptcy process has significantly affected bankruptcy
outcomes. For example, Bharath et al. (2010) show that the increasing use of debtor-
in-possession financing and key employee retention plans are associated with a declining
trend in APR deviations. While we find similar results with respect to the use of KERPs
and APR deviations, our focus is on understanding the use of KERPs in bankrupt firms
and in examining the effects of KERPs on a number of other bankruptcy outcomes.5
What role do creditors play in a firm’s decision to offer retention bonuses to its key
employees? If retention bonuses are a symptom of agency conflicts between managers and
creditors, greater creditor control should result in fewer instances of retention bonuses to
managers. However, if retention bonuses are offered as part of creditors’ value-maximizing
strategy, creditor control should increase the likelihood of KERP adoptions. The two
views also yield different predictions regarding how KERPs affect bankruptcy outcomes.
If KERPs align employee incentives with those of creditors, creditor outcomes should
improve with KERPs. Thus, KERPs should influence reorganization versus liquidation
decisions, time spent in bankruptcy, and absolute priority deviations.
The controversy surrounding retention bonuses led Congress to amend the U.S.
bankruptcy law in 2005. The new legislation – known as the Bankruptcy Abuse Pre-
vention and Consumer Protection Act of 2005 (BAPCPA) – introduced section 503(c)
5In a related paper, Crutchely and Yost (2008) examine KERP programs and show that firm sizeincreases the likelihood of KERPs. They also show that firms with KERPs spend longer in bankruptcy.Since KERPs are adopted in large and complex bankruptcies, it is unclear if KERPs actually causebankruptcy duration to increase. We deal with such endogeneity issues by examining employees’ outsideoptions as instruments and find that incentive plans result in a quicker restructuring process, althoughretention plans do not. Our study covers a larger sample of bankruptcies and a longer period in examiningwhy firms adopt KERPs and the effect that such plans have on bankruptcy outcomes.
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into the Bankruptcy Code: “a bankruptcy court is not to authorize payments to an ‘in-
sider’ for the purposes of inducing the person to stay with the debtor unless the court
determines that (a) he or she has a bona fide job offer from another company at the same
or higher compensation, (b) the individual provides services that are essential to the sur-
vival of the business, and (c) the retention payment is less than 10 times the average
compensation of a similar kind given to nonmanagement employees during the calendar
year”.
The new rules have dramatically changed the bonus plans offered by bankrupt firms
since 2005. As we will show later, BAPCPA resulted in retention plans becoming less
common while incentive plans gained popularity. In these performance-based pay plans,
firms offer bonuses which are contingent on their achieving a predetermined milestone.
These milestones are typically related to bankruptcy outcomes (reorganization versus
liquidation), speed of reorganization, debt recoveries, EBITDA, and enterprise value at
emergence. Bonus plans that are intended to provide incentive compensation to manage-
ment employees are subject to a more liberal review process under Bankruptcy Code 363.
Given the new legislation restricting the payment of retention bonuses, it has become even
more important to distinguish retention plans from those that provide incentive bonuses
in improving creditor outcomes.
3 Data Sources and Sample Description
3.1 Data
The present study begins with a sample of all Chapter 11 bankruptcy filings included
in the UCLA-LoPucki Bankruptcy Research Database (BRD) during the period from
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1996 to 2007. The 497 Chapter 11 filings in the UCLA-LoPucki database include the
bankruptcies of all public firms with reported assets in excess of $100 million (in 1980
constant dollars) as of the last Form 10-K filed with the SEC pre-bankruptcy petition.
The filings are cross-checked with New Generation Research’s BankruptcyData.com to
verify their Chapter 11 status. Filings that were dismissed by the court (11 cases), cases
still pending as of December 31, 2008 (12 cases), financial firms (37 cases), utilities (11
cases), and firms headquartered outside of the U.S. (9 cases) are excluded.6 The resulting
sample of 417 firms in Chapter 11 is matched to Compustat in order to obtain firm-
level financial data. If information is missing in Compustat, it is filled in manually using
information from 10-Ks (obtained from EDGAR).
We identify firms with KERPs through a search of Bankruptcydata.com, 8-K filings,
reorganization/liquidation plans, and Factiva News Retrieval, using keywords that are
related to the use of retention and incentive bonus plans.7 The court documents re-
lated to KERP approvals are obtained from bankruptcy courts (specifically, through their
respective Public Access to Court Electronic Records (PACER) websites).8 The court
documents provide detailed information on KERPs, including the identity of the key em-
ployees to be covered, the purpose of the retention program, bonus amounts, and other
plan details.
6Financial firms and utilities are excluded because of differences in regulations and accounting stan-dards for these industries. Firms headquartered outside the U.S. are excluded because we require infor-mation on other firms located around the headquarter of the Chapter 11, and such location informationis only available for U.S. firms. Of the nine firms headquartered outside the U.S., one is in Argentina,two are in Canada, and another six are in Bermuda.
7The keywords that we use include “retention plan”, “bonus plan”, “incentive plan”, “retentionbonus”, “pay-to-stay”, “bankruptcy pay”, “managerial incentive”, “key employee”, “KERP”, “KEIP”,“KMIP”, and “KECP”.
8Every bankruptcy court maintains a PACER website, which contains the docket sheet for abankruptcy case. KERP motions and approvals for Chapter 11 firms are obtained through PACERin about two-thirds of the cases. For another 30% of the cases, we retrieve motions and orders directlyfrom U.S. bankruptcy courts, National Archives, and Parcels, Inc. For the remaining 4% of the cases, wecollect as much information as possible from company filings with SEC and news articles.
9
The Bankruptcy Research Database and Bankruptcydata.com are our primary sources
for basic information about bankruptcy filings, including the type of filing, the outcome of
the Chapter 11 process, and the months spent in restructuring. Bankruptcydata.com also
provides reorganization and liquidation plans with information on the classes of claims,
the dollar amount of allowed claims, recovery, and whether cash or security was given
to each class of claimant. In the event that a plan is not available in this database, we
obtain the information from the relevant 8-K filings or purchase the reorganization plans
directly from U.S. bankruptcy courts. Information about debtor-in-possession financing
and top management turnover is obtained mainly from Bankruptcydata.com, PACER,
and Factiva/LexisNexis. The institutional ownership data are obtained from 13F filings
provided by the Thomson Reuters Ownership Database.
We identify CEOs at the time of KERP approval and determine the CEO’s founder
status, age, and tenure from proxy statements and 10-K filings. We further determine
whether the CEO is an incumbent or newly hired. Newly-hired CEOs are defined as
those who are hired during a period starting three years before Chapter 11 filing and
ending with KERP approval. In cases of CEO changes, we determine whether new CEOs
are internal promotions or external hires. Through a perusal of news articles around
CEO appointments, we also identify whether or not the newly-hired CEO is a turnaround
specialist. The governance variables (including board size and the fraction of independent
directors) are collected from the firm’s last 10-K or proxy statements before bankruptcy
filing.
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3.2 Summary Statistics
Table 1 provides an annual distribution of firms adopting KERPs. Column (1) provides
an annual distribution of all Chapter 11 filings in our sample. Consistent with the well-
known relation between business cycles and financial distress, we observe a clustering of
bankruptcies in the early 2000s, a period that coincides with the U.S. recession. Column
(2) provides a distribution of firms using KERPs. About 39% of Chapter 11 firms in
our sample adopt KERPs. Consistent with the trends reported in Skeel (2003), Bharath
et al. (2010), and Jiang et al. (2012), we find that KERPs are more common in the recent
period; in the mid-to-late 1990s, less than one-third of the Chapter 11 firms adopt KERPs,
yet this number increases to over 50% in the later part of the sample period.
We classify KERPs into those which offer only retention bonuses, those which offer
both retention and incentive bonuses, and those which offer only incentives bonuses. Re-
tention bonuses are a common feature of the bonus plans adopted by firms in bankruptcy.
Among firms with KERPs, approximately 88% offer retention bonuses. In about half of
these cases, firms additionally pay incentive bonuses. There is a dramatic decline in the
use of retention bonus plans after 2005, which coincides with the enactment of BAPCPA.
As described in Section 2, BAPCPA placed severe restrictions on the payment of retention
bonuses which, in turn, resulted in an almost complete shift wherein firms developed a
preference for incentive bonuses over retention bonuses.
Panel A of Table 2 provides mean and median values of firm characteristics in the
pre-filing year. The sample firms are large, with average assets of $2 billion (in constant
2008 dollars) and a median asset value of $0.7 billion. The large sizes of bankrupt firms
in the sample are unsurprising, as BRD includes only large filings. Chapter 11 firms are
substantially overlevered, as one would expect; their average total liabilities to assets ra-
11
tio is 1.02 (the median is 0.92). The industry-adjusted leverage is 0.44, which indicates
significant distress.9 Firms are not only overlevered; they are also unprofitable. The
average industry-adjusted operating performance (measured as earnings before interest,
taxes, depreciation and amortization (EBITDA), scaled by assets, and adjusted for in-
dustry performance) is -0.07 (the median is -0.05). Secured debt represents about 42% of
assets. Institutions own about 27% of the firm’s stock at the time of filing.
Panel B reports descriptive statistics on bankruptcy filings. About 29% of the Chapter
11 filings are prepackaged bankruptcies in which reorganization plans are negotiated and
voted on by shareholders and creditors before bankruptcy filing. The simultaneous filing
of both the bankruptcy petition and the reorganization plan considerably shortens the
time that companies spend in bankruptcy.10 About 67% of the bankrupt firms obtain
debtor-in-possession financing. Roughly 44% of the bankruptcies are filed in Delaware.
Creditors’ committees are common; about 85% of firms have such committees approved
by court. By contrast, equity committees are less common and exist in only 11% of
bankruptcy cases.
The priority of claims is sometimes violated in Chapter 11 bankruptcy when a junior
claimant (which is often equity) receives some payment even though senior claimants are
not paid in full. Many bankruptcy scholars argue that deviation from APR happens be-
cause Chapter 11 is debtor-friendly, resulting in shareholders (or the managers supporting
them) having a significant ability to impose costs on creditors through tactics designed to
9We obtain the industry-adjusted characteristic by subtracting the median-industry characteristic(based on the two-digit SIC code) from the comparable characteristic for each firm.
10Tashjian et al. (1996) provide descriptive information on a sample of 49 prepackaged Chapter 11bankruptcies. They show that prepackaged bankruptcies incur lower direct cost of bankruptcy, resultin higher debt recoveries than traditional Chapter 11 filings, and the distressed firms spend less time inbankruptcy.
12
delay the resolution of bankruptcy. These tactics are costly to creditors and, as a result,
senior claimants sometimes agree to accept less than the contractual value of their claims.
To estimate the APR deviation, we obtain information about the type and amount of
new securities various claimant classes receive in the final reorganization plan approved
by court. The recovery to each class is estimated by adding up the values of cash and new
securities each class receives. Except for debt (for which we use the face value) other secu-
rities are valued using traded prices that most accurately post date the firm’s emergence
from bankruptcy. These traded prices are obtained from various sources, including CRSP,
Bloomberg, Datastream, and the Bankruptcy DataSource. An APR deviation is deemed
to have occurred if equity holders receive a payment before other senior claims are paid
in full.11 We use this information about APR deviation to construct an indicator variable
that takes a value of one if there is any APR deviation, and a value of zero otherwise.
APR deviations are not commonplace and occur in about 17% of bankruptcy cases. The
literature shows that APR deviations were much more common in the 1980s and in the
1990s (see Weiss (1990) and Adler et al. (2006)). Our observation of the decline in APR
violations is consistent with the findings of Bharath et al. (2010).
Panel C shows the mean and the median of the three governance variables and CEO
characteristics at the time that KERPs are adopted. The average board has 7 members,
71% of which are classified as independent directors. In about half of the cases, the CEO
is also the chairman of the board. Founder-CEOs are present in 15% of the cases. CEOs
are, on average, 53 years old and have worked in their current position for about 4 years.
Consistent with the substantial turnover commonly observed in distressed firms, only
about 41% of the CEOs are incumbent (i.e., they have not been replaced in the last three
11See, for example, Eberhart et al. (1990), Betker (1995), and Jiang et al. (2012).
13
years before Chapter 11 filing). A little more than half of the new CEOs are external
hires. About 20% (48 of 239) of the new hires are turnaround specialists.
Panel D provides a distribution of Chapter 11 outcomes. An outcome is classified as a
reorganization if there is evidence that the firm has reorganized and emerged from Chapter
11 status. Similarly, an outcome is classified as a liquidation if the firm’s assets are sold
piece-meal, and as an acquisition if all of the firm’s assets are acquired by another firm.
Firms reorganize and emerge from Chapter 11 in about 60% of the cases. Liquidations
happen in about 29% of the cases and the remaining 11% of the firms are acquired. The
last two columns of Panel D provide the mean and median time spent in bankruptcy,
measured as the number of months between the filing date and the confirmation date of
the plan. Across all cases, the average duration from the month of filing bankruptcy to
reorganization, acquisition, or liquidation is about 17 months (the median is 13.5 months).
The average duration of bankruptcy decreases from 21 months at the beginning of our
sample period to 12 months in the more recent 2004-2006 period. The decrease in average
bankruptcy duration is also evident in the literature. Frank and Torous (1994) report
an average duration of 30 months during the 1983 to 1988 period; Bharath et al. (2010)
report an average duration of 18 months for the more recent period. Firms that reorganize
spend less time in bankruptcy than firms that are liquidated or acquired.
Table 3 provides summary statistics of KERPs. The average plan covers about 2%
of the firm’s employees. The employees are classified into three tiers: the highest tier
consists of a few top managers being paid larger bonuses, while the lowest tier consists of a
greater number of managers being paid smaller bonuses. In the highest tier, a median of 6
employees receive retention bonuses that represent about 75% of their salaries. Conversely,
in the lowest tier, a median of 46 employees receive retention bonuses that represent about
30% of their salaries.
14
Incentive bonuses are offered to even fewer employees; a mere 1% of the employees
receive them. The employees covered by incentive plans are similarly divided into three
tiers. CEOs are included in about 80% of these plans. The plans almost always include
other senior managers (99% of retention plans and 95% of incentive plans include non-
CEO executives). Other mid-level employees are also included frequently.
About 85% of retention plans tie retention bonuses to a minimum-stay (i.e., a firm
pays a bonus if the executive stays with the firm for a pre-determined period). The typical
plan requires managers to stay for at least 9 months following the KERP initiation date
in order to qualify for bonuses. About 52% of retention plans promise additional bonuses
tied to stay till plan confirmation.
In 97 of the 417 Chapter 11 filings (or 23%), key employees’ compensation is explicitly
tied to the resolution of the firm’s bankruptcy and/or other outcomes directly affecting
payoffs to creditors. By comparison, far fewer firms tied executive compensation to cred-
itor’s wealth in the 1980s (Gilson and Vetsuypens, 1993). A large proportion of KERPs
make incentive bonus payments contingent on bankruptcy resolution (78%). Roughly
48% of these plans offer bonuses contingent on the firm’s emergence from Chapter 11 and
another 30% pay bonuses upon the sale of assets or the firm’s liquidation. Incentive plans
that offer bonuses that are tied to EBITDA and enterprise value targets are also common.
Less common are incentive plans that tie employee payments to the speed of restructuring
or to debt recovery (about 13% of the incentive bonus plans include these features).
The overall cost of the average plan is about $8.5 million for retention bonuses and
about $7 million for incentive bonuses. The maximum financial pool allocated for bonus
plans averages about $9 million for retention plans and $16 million for incentive plans.
These plan costs, representing about 0.4% of pre-filing assets, appear small when com-
pared to professional legal fees paid in bankruptcy, which, according to LoPucki and Do-
15
herty (2004), could be as large as 2% (in a sample of 48 large public company bankruptcies
from 1998 to mid-2002).
4 Explaining the Use of KERPs in Chapter 11
4.1 Logit Results
We begin by examining the relation between creditor control and KERP adoption. Ay-
otte and Morrison (2009) suggest that creditors, in the most recent decade, have come to
dominate the Chapter 11 process. If bonus plans benefit creditors, then the greater influ-
ence of creditors in Chapter 11 should result in the more frequent adoption of KERPs.
We employ two measures of creditor power: (a) the presence of a creditors’ committee,
and (b) the presence of debtor-in-possession financing. The existence of a creditors’ com-
mittee indicates that unsecured creditors have an influence on bankruptcy restructuring.
According to Henderson (2007), creditors’ committees are often involved in negotiating
employment agreements and determining managerial pay. Jiang et al. (2012) show that
the managers of hedge funds often seek representation on a creditors’ committee to influ-
ence bankruptcy process. The active role of creditors in bankruptcies suggests that they
are likely to reject bonus packages that do not improve creditor outcomes.
We use debtor-in-possession (DIP) financing as our second measure of creditor control,
as Skeel (2004) argues that DIP financing has become a new tool of governance in Chapter
11. Through DIP financing, creditors gain a significant amount of control through loan
agreements and subsequently exert control over the restructuring decisions of bankrupt
firms.
16
Table 4 presents results from logit regressions where the dependent variable takes a
value of one if the firm adopted a KERP and zero otherwise. The results show that both
measures of creditor control have the predicted positive relation with KERPs and both
are statistically significant. The strong positive coefficients on the presence of creditors
committee and the DIP financing suggest that greater creditor control is associated with
a higher likelihood of key employee retention plans in Chapter 11. The estimates suggest
that the probability of KERP adoption is 34% higher in firms with a creditor’s committee
than those without such a committee, keeping all other variables at their means. Similarly,
the probability of KERP adoption is 24% higher in firms that receive DIP financing
compared to those that do not.
In Column (2), we additionally include variables that measure employees’ outside job
opportunities. Firms facing a greater threat of employee turnover are more likely to adopt
KERPs. Previous research shows that bankruptcies result in a significant increase in CEO
turnover. This should also be correlated with high turnover among non-CEO executives.12
If firms optimally adopt retention plans to induce employees to stay with the firm, then
they are more likely when there is a greater threat of employees leaving the firm.
Whether employees switch firms or not depends on the ease with which they can find
alternative employment. Geographic considerations are important because managers find
moving disruptive and costly (Almazan et al., 2007). With many potential employers in
a local market, employees have fewer concerns about the loss of earnings from leaving
their current firm. Consistent with this argument, Kim (2011) finds that wage losses are
greater in labor markets with fewer potential employers in the local industry.
Following Lazear (2009), we label employment markets where there are many
same-industry firms in the same geographic area as thick employment markets
12Fee and Hadlock (2004) show that non-CEO turnovers are elevated around CEO dismissals.
17
(ThickEmplMarkets). In the context of such markets, managers enjoy greater job op-
portunities, and suffer smaller wage losses from switching employers while bankrupt firms
find it more difficult to retain employees unless they provide explicit “pay-to-stay” or
incentive bonuses. The variable ThickEmplMarkets takes a value of one if there are at
least twenty other firms in the same two-digit industry within a 100-kilometer radius from
the sample firm’s headquarter.13 Alternative cutoffs, based on both the number of firms
and the size of the geographic area, yield similar results. The positive and statistically
significant coefficient for the ThickEmplMarkets variable is consistent with the argument
that the availability of alternative job options increases retention bonus payments. The
effects are also economically large. The probability of KERP adoption is 33% higher for
bankrupt firms operating in thick employment markets than for firms not operating in
such markets.
As another proxy for employees’ propensity to change jobs, we include the median
industry cash compensation growth (IndCompGrowth).14 A higher growth in cash com-
pensation in comparable firms implies greater pay disparities between the pay of execu-
tives at the bankrupt firm and the pay of those at comparable firms. Consistent with our
prediction, we find that a higher cash compensation growth in the median industry firm
positively affects the likelihood of KERP adoption. A one standard deviation increase in
median industry cash compensation growth increases the probability of KERP adoption
by about 6%.
13The distance of a company’s headquarter to all other Compustat firm headquarters is estimated usingthe Haversine formula. See http://en.wikipedia.org/wiki/Great-circle distance.
14We focus on cash compensation rather than total compensation because equity-based compensationis less relevant for firms in bankruptcy. Cash compensation is tied much more closely to short-termperformance targets. For example, Yahoo’s 2012 proxy statement states that their annual cash bonus“is intended to focus on, and reward the achievement of short-term goals that are important to theCompany.” Cash compensation is estimated as the average salary and bonus payments for the top-five paid non-CEO executives. We use firms in Execucomp to calculate the annual growth rate of cashcompensation of senior executives for all 2-digit SIC industries (excluding the firm in question).
18
Yet another proxy for employee outside job options is whether the industry is in
distress. Fewer jobs are available in distressed industries. As such, the presence of such
industry-wide distress reduces a firm’s incentives to offer retention bonuses. We follow
Acharya et al. (2007) in classifying an industry as distressed if the industry median stock
return for the year before the Chapter 11 filing is -30% or less. The coefficient for the
distressed industry dummy is negative, although its significance level is weak (p=0.11).
The results suggest that firms operating in distressed industries have a marginally lower
likelihood of using KERPs.
In Columns (3) to (5) we add the three governance variables: the fraction of indepen-
dent directors, CEO-chairman duality, and board size. If KERP adoption is a reflection
of agency problems we should observe that firms with weaker boards and powerful CEOs
have a higher likelihood of adopting KERPs. We find no such evidence. Both the fraction
of independent directors and CEO-Chairman duality variables are insignificant. Only the
board size variable carries a positive sign and is statistically significant at the 5% level.
The board size variable does not have a unique interpretation. Larger boards could be
a proxy for greater firm complexity, which, in turn, could explains why firms with larger
boards are more likely to adopt KERPs.15
The regression specifications control for firm size, the pre-packaged bankruptcy indi-
cator, the Delaware filing indicator, and industry-fixed effects.16 We find that firm size
significantly affects the propensity of a firm to adopt KERPs. A one standard deviation
change in firm size increases the likelihood of KERP adoption by 10% (with all other
variables held at their means). The positive relation between firm size and the likelihood
15The board literature shows that complex firms have larger boards. See, for example, Coles et al.(2008) and Lehn et al. (2009).
16In unreported tables, we find that bankruptcies are relatively more common in manufacturing,telecommunications, and in wholesale and retail industries while they are less common in oil and gas,chemical, and healthcare industries.
19
of KERP adoption has two alternative interpretations. If firm size is a proxy for agency
problems, then one could infer that managers of large firms boost their wealth by paying
themselves retention bonuses. However, firm size could also be a proxy for bankruptcy
complexity, where this complexity increases the demand for management continuity.
The coefficient for the pre-packaged filing indicator is negative and statistically sig-
nificant at the 1% level. The estimates suggest that firms opting for pre-packaged
bankruptcies have an 18% lower likelihood of KERP adoption than those sticking to
regular bankruptcies. The pre-packaged nature of these filings means that plans are pre-
negotiated to include less flexibility for managers. Thus, in these cases, there are fewer
incentives to provide retention and incentive bonuses. The coefficient for the Delaware
dummy is statistically insignificant.
In Table 5, we extend these results to a multinomial logit framework that examines a
firm’s decision to offer retention-only bonuses separately from its decision to offer incentive
bonuses (with or without retention bonuses). The results from these additional tests are
generally consistent with those presented above. Overall, we find that firms are more
likely to adopt both types of plans where there is a creditors’ committee and where lenders
provide DIP financing. The results show that creditors’ committees more strongly predict
the adoption of retention-only plans, while the presence of DIP lenders more strongly
predicts plans with incentive bonuses. While ThickEmplMarkets positively predicts
adoption of both types of plans, the other two measures of employees’ outside options
only affect the plans with incentives. Another difference between the results in this table
and those in Table 4 is that board size does not affect the likelihood of adoption of
retention-only plans, whereas it positively affects the adoption of plans with incentive
bonuses.
20
4.2 Explaining Plan Features
Table 6 presents Tobit estimates from regressions that relate bonus plan features to var-
ious firm and bankruptcy characteristics. These regressions examine whether or not the
firm and bankruptcy characteristics explain the size of these plans along a number of
dimensions, including the fraction of key employees covered in the bonus pool, the size
of the bonus paid to the highest tier, and plan costs as a fraction of pre-filing assets.17
Columns (1) to (4) present results for retention bonuses, while columns (5) to (8) present
results for incentive bonuses.
The results show that larger firms include more employees in the plan, offer bonuses
which are a larger fraction of employees’ salaries, and commit more financial resources (as
a fraction of assets) to the plan. The pre-packaged plans, on the other hand, offer smaller
bonuses and commit a smaller fraction of their assets to the bonus pool.
Both DIP financing and the presence of creditors’ committees result in a larger per-
centage of employees receiving retention bonuses and the bonuses at such firms are a
larger fraction of their assets. In other words, greater creditor control increases retention
plan costs. However, the effects documented for incentive bonuses in Columns (5) to (8)
suggest that creditor control has no effect on incentive bonus amounts and plan costs.
ThickEmplMarkets positively affect the plan sizes and plan costs for the payment of
retention bonuses but not for incentive bonuses. On the other hand, IndCompGrowth
positively affects plan sizes and costs for incentive bonuses but not for retention bonuses.
17The motions and orders for KERP adoption provide either target percentage bonus or the dollarvalue paid to key employees. We use the percentage value directly if it is quoted in court documents. Ifthe documents provide dollar amounts, we convert them to a percentage by dividing the bonus amountsby CEO salary in the last fiscal year before Chapter 11 filing. The percentage bonus paid to top tierexecutives in our sample ranges between 4 percent and 200 percent for retention plans, and between 7percent and 844 percent for incentive plans, respectively.
21
4.3 CEO Participation in KERPs
We examine CEO participation in KERPs to test if “failed and entrenched” CEOs use
retention bonus plans for self-serving purposes. If the use of KERPs reflects agency prob-
lems, then we would expect to see that entrenched top executives are a part of retention
plans. Furthermore, weak governance will make it more likely that CEOs participate.
However, if KERPs are an equilibrium response to contracting problems in bankruptcy,
we expect to see no relation between CEO characteristics, governance, and CEO partici-
pation in KERPs.
Table 7 presents logit estimates predicting CEO participation. In columns (1) to (4),
we examine CEO participation in all KERPs regardless of whether they are retention-only
plans, or plans with both retention and incentive features, or plans with just incentive
bonuses. Thus, in these columns, the dependent variable takes a value of one if the CEO
participates in a KERP, and is zero otherwise. In columns (6) to (8), we focus on CEO
participation in plans with incentive bonuses to examine if the effect differs when we
exclude retention-only bonus plans. Here, the dependent variable takes a value of one if
the CEO receives incentive bonuses, and is zero otherwise.
The independent variables include various CEO characteristics: CEO age, CEO
tenure, CEO founder status, and the dummy variable for an incumbent CEO. In the
specification reported in column (2), we consider CEOs who are promoted internally and
those who are hired externally, and CEOs who are turnaround specialists. Additional
specifications include governance variables and firm characteristics.
The results reported in Table 7 show that, of all CEO characteristics, only turnaround
specialists have a higher likelihood of receiving retention bonuses. However, turnaround
specialists are not any more likely to receive incentive bonuses (as seen from estimates in
22
Columns (5) to (8)). This reflects the importance of retaining turnaround specialists to
the distressed firms that hire them. There is also some evidence that old managers are
less likely to be included in incentive bonus plans.
Overall, the findings are contrary to the media perception that KERPs are used to
enrich failed managers. Among the governance variables, only board size predicts CEO
participation in KERPs. Once again, it is not clear if governance is weak in firms with
bigger boards. Greater board size most likely reflects bankruptcy complexity, and bonuses
to CEOs in such cases may be optimal from a creditor’s perspective. Other than the
board size variables, creditor control measures are the only measures that are statistically
significant in these regressions. The results suggest that greater creditor control increases
the likelihood that CEOs are covered by KERPs.
Overall, our inability to explain the inclusion of CEOs in the bonus plans as a func-
tion of CEO characteristics and governance suggests that firms make optimal decisions
regarding CEO participation in KERPs.
5 KERPs and Bankruptcy Outcomes
In the previous section, we show that creditor control has predictive power for KERP
adoptions by bankrupt firms. This raises the question of whether or not KERPs im-
prove bankruptcy outcomes for creditors. Estimating the effect of KERPs on outcomes is
not straightforward, since firms optimally determine when to use bonus plans. A firm’s
decision regarding the use of KERP can be specified as a function of the X variables
below.
23
KERP ∗i = Xiβ + εi (1)
Firms adopt KERPs if Xiβ + εi is positive.
KERPi =
1 if KERP ∗
i > 0,
0 if KERP ∗i ≤ 0
(2)
The bankruptcy outcome is a function of the Z variables and whether or not the firm
has adopted a KERP.
Outcomei = Ziγ + µKERPi + ηi (3)
The outcome variables we focus on include bankruptcy resolution (emergence ver-
sus liquidation), time spent in bankruptcy, and deviation from APR. Econometrically,
a selection problem amounts to a non-zero correlation between the error disturbances
in equations (1) and (3). To identify the outcome models, we rely on two instrumental
variables that predict the adoption of KERPs but not bankruptcy outcomes. Both of
our instruments are related to employees’ outside options. We know from Section 4 that
KERPs are adopted more frequently in bankrupt firms with greater employment options
for employees (measured by ThickEmplMarkets). We do not expect a geographic con-
centration of same-industry firms to affect bankruptcy outcomes directly except through
their influence on KERP adoption. Our second instrument is the median industry cash
compensation growth (IndCompGrowth), which affects the propensity of employees to
change jobs because of an increasing wage gap between the bankrupt firm and its peers.
Our results reported in Section 4 suggest that a higher growth in industry cash compen-
24
sation increases the likelihood of KERP adoption. However, with this variable, there is
a concern that industry cash compensation growth may be correlated with industry out-
comes which may somehow affect bankruptcy outcomes. Thus, in discussing our results,
we place a greater emphasis on our first instrumental variable (ThickEmplMarkets) than
the second.
The Zi variables include firm size, leverage, profitability, the prepackaged bankruptcy
indicator, Delaware-bankruptcy indicator, the industry-in-distress indicator, the secured
debt scaled by assets, and variables measuring creditor control. All of these variables are
known to affect the likelihood of emergence from bankruptcy (Lemmon et al., 2009; Jiang
et al., 2012). In the regressions, the Xi variables contain the two instrumental variables
in addition to a full overlap with Zi variables.
With binary-outcome variables and binary-endogenous explanatory variables, the ap-
propriate estimation method is a bivariate probit model (see Woolridge (2002 Chapter
15.7.3)). With continuous-outcome variables, the appropriate estimation method is a
treatment regression model (see Maddala (1983)). All of the models are estimated using
the maximum-likelihood estimation method. In Columns (1) to (3) of Table 8, we ex-
amine the effect of KERPs on the bankruptcy outcomes. However, KERPs include both
retention-only plans and plans that provide incentive bonuses. Since incentive bonus plans
more directly tie the bonuses to outcomes, we expect the effect of incentive bonus plans on
outcomes to be stronger. We, therefore, examine the effect of plans that include incentive
bonus plans on outcomes in Columns (4) to (6).
25
5.1 KERPs and Bankruptcy Outcomes
Column (1) presents result from bivariate probit regressions that explain the likelihood of
a firm’s emergence from bankruptcy. The dependent variable is an indicator variable that
takes a value of one if the firm reorganizes and zero if the firm liquidates or is acquired.
The predictions on how bonus plans affect the likelihood of bankruptcy reorganization
are complex and nuanced. KERPs provide retention bonuses that compensate managers
to stay at the firm until a specified date (or until plan confirmation). In many bankrupt-
cies, creditors prefer the firm to reorganize. But in others, creditors prefer the firm to
liquidate. There are no clear predictions on how the provision of pay-to-stay bonuses will
affect emergence since in both reorganizations and liquidations, creditors will want key
employees to stay at the firm until the bankruptcy is resolved. The results in column
(1) show no relation between the existence of bonus plans and the probability of a firm’s
emergence.
In column (2), we present the treatment regression results that examine the effect
of KERPs on the duration of bankruptcy. Bankruptcy costs are a function of the time
spent in bankruptcy. Thus, we expect creditors to be sensitive to, and invested in, the
expeditious resolution of bankruptcy.18 The question we pursue here is whether or not
KERPs affect the duration of bankruptcy.
Retention plans that pay bonuses contingent on managers’ staying for a minimum
length of time should have no effect on bankruptcy duration. However, retention plans
that pay bonuses at plan confirmation should provide incentives for managers to speed
up bankruptcy (assuming that managers have positive discount rates). However, the
results show no significant relation between KERPs and bankruptcy duration. While
18LoPucki and Doherty (2004) provide estimates suggesting that doubling the time a case remainspending increases fees by about 57%.
26
the coefficient estimate on KERP adoption is negative, it is statistically indistinguishable
from zero.
The results in Section 4 show that greater creditor control is associated with an in-
creased use of KERPs. In light of these findings, a logical question to ask is whether or
not the use of KERPs reduces the ability of shareholders to obtain payoffs from creditors
(as evidenced in APR deviations). Furthermore, Bharath et al. (2010) recently show that
APR deviations have been declining since the early 1990s. Bharath et al. attribute this
decline to increasing creditor control in bankruptcies, since an increase in creditor control
coincides with an increase in DIP financing and the adoption of key employee retention
plans. The increase in DIP financing and KERPs during the 1990s is also documented by
Skeel (2003).
In Column (3), we examine the extent to which KERPs mitigate absolute priority
deviations. If bonus plans are promoted by creditors, then such plans would strengthen
creditor rights and reduce the costs that the bankruptcy process imposes on creditors,
including deviation from the absolute priority rule. The coefficient on the KERP indicator
is negative but the estimate is not statistically significant.
Overall, we conclude that KERPs do not materially improve outcomes for creditors.
The likelihood of emergence from bankruptcy is unrelated to the provision of retention-
only bonuses; the time spent in bankruptcies in firms offering such plans is no different,
and the plans have no effect on APR violations.
5.2 Incentive Plans and Bankruptcy Outcomes
Since much of the criticism of KERPs is about retention-only plans, we next examine
if results differ when we examine the effect of incentive bonus plans relative to firms
27
that offer no bonuses or offer only retention bonuses. The incentive bonuses are often
contingent on the firm achieving a certain outcome or the firm reaching a pre-determined
milestone. These objectives are more frequently aligned with the interests of creditors.
Thus, contrary to the findings above, we expect incentive bonus plans to significantly
improve outcomes.
Columns (4) to (6) of Table 8 examine the effect of incentive bonus plans on the three
bankruptcy outcomes. The incentive-plan indicator takes a value of one if plans include
incentive bonus payments to key employees, and a value of zero otherwise. As described
earlier, many KERPs include incentive bonuses together with retention payments, while
a small number of plans include only incentive bonuses. In both cases, the incentive-plan
indicator is coded as one. As before, the regressions control for firm and bankruptcy
characteristics that are important in determining outcomes.
Incentive bonus plans frequently tie the compensation of key employees to a firm’s
emergence from Chapter 11, or to performance indicators that are tied to either EBITDA
or the enterprise value at emergence. Since incentive plans more frequently tie bonuses to
emergence rather than to liquidation, we expect the overall effect of incentive bonuses on
emergence to be positive. The bivariate probit estimates reported in column (4) confirm
this prediction. In Table 9, we separately examine the effect of these objectives on the
likelihood of emergence.
In column (5), we examine how the presence of incentive bonus plans is related to the
time spent in bankruptcy. Many incentive bonus plans directly tie bonuses to the speed
with which a bankruptcy is resolved. Specifically, managers are offered larger bonuses if
the plan is confirmed early; the firm will gradually reduce bonus payments as the plan
confirmation date moves into the future. The estimates show that the use of incentive
bonuses significantly reduces time spent in bankruptcy. The effect of incentive plans on
28
bankruptcy duration is much stronger compared to that in Column (2) where we examined
all plans (including the retention-only plans).
In column (6), we examine the effect of incentive bonus plans on the likelihood of
APR violation in Chapter 11. As discussed earlier, if bonus plans improve outcomes
for creditors, then they should reduce the costs that the bankruptcy process imposes on
creditors, including deviation from the APR. Consistent with this prediction, we find that
the coefficient on the incentive plan indicator is significantly negative.
The coefficient estimates on control variables have the predicted signs. The coefficient
estimate on Ln(assets) in emergence regressions is positive, although it is not statistically
significant.19 We expect leverage to affect positively the probability of emergence because
high leverage indicates that the firm suffers from financial, rather than economic, distress.
In addition, creditors of highly-levered firms are likely to favor continuation, given that
the claims of highly-levered firms are more risky. Consistently, we find that firms are more
likely to emerge if they have high leverage. Furthermore, we expect firms to have a higher
likelihood of emergence in pre-packaged bankruptcies, as a plan of reorganization often
accompanies a bankruptcy petition at filing. The results strongly support this prediction
as the coefficient estimates on pre-packaged bankruptcy are positive and significant at the
1% level in Columns (1) and (4). The Delaware filing dummy is negatively associated
with emergence.
We find that the presence of a creditors’ committee, a measure of bankruptcy com-
plexity, is associated with a longer time spent in bankruptcy. As expected, pre-packaged
bankruptcies are resolved more quickly. The only other variable that is significant in
19Larger firms are more likely to be reorganized because larger firms are more costly to liquidate dueto the financing constraints faced by potential buyers (Shleifer and Vishny, 1992; Aghion et al., 1992).Larger firms also have a considerably larger scope when reorganizing assets through restructuring andoperating improvements (Denis and Rodgers, 2007; Barniv and Agarwal, 2002; Lemmon et al., 2009).
29
the duration regressions is the presence of an equity committee, which is associated with
longer time spent in bankruptcy. Finally, the results suggest that APR violations are more
common in pre-packaged bankruptcies. These results are consistent with those reported
in Tashjian et al. (1996).
Overall, the findings suggest that bonus plans that offer incentive bonuses to key
employees increase the likelihood of a firm’s emergence from bankruptcy, reduce the time
that firms spend in bankruptcy, and lower the likelihood that APR is violated.
5.3 Plan Objectives and Bankruptcy Resolution
Table 9 examine whether specific objectives in retention and incentive plans differently
affect the probability of emergence. We focus on those plan objectives which appear most
frequently in KERPs. The logit estimates presented in Columns (1) and (2) show that
specific plan objectives in retention plans have no predictive ability in explaining a firm’s
emergence from bankruptcy. This finding is not surprising, since retention bonuses are
based on a minimum stay or on the length of stay until plan confirmation (which could
be either through a reorganization or liquidation).
Columns (3) to (6), on the other hand, examine the three specific objectives that are
commonly observed in incentive bonus plans. As described earlier, many of the bonus
plans link incentive payments to the firm’s emergence from Chapter 11. Many other
plans link bonuses to asset sales. These two objectives should have opposite effects on
the likelihood of a firm’s emergence. Column (3) examines the likelihood of emergence
when firms offer incentive plans that tie bonuses to emergence. The expected positive
coefficient on the emergence objective indicator suggests that emergence is more likely
when bonuses are linked to emergence. Conversely, results in column (4) show that
30
when the plan objective is to sell assets, emergence is less likely. Overall, the results
strongly suggest that incentive bonuses are important in explaining a firm’s emergence
from bankruptcy. In column (5), the effect of incentive bonus plans that link incentive
bonuses to targets based on firms’ EBITDA upon emergence is examined. The presence
of such plans is likely to once again positively affect emergence. The positive coefficient
on the EBITDA objective indicator is consistent with this prediction.
The fact that specific plan objectives differently affect the likelihood of a firm’s emer-
gence suggest that the nature of incentives matters significantly in bankrupt firms. The
stronger findings on the effect of incentive plans on outcomes suggest that provision of
incentive bonus payments significantly improves outcomes for creditors.
6 Conclusion
This paper examines the determinants of retention and incentive bonus plans in Chapter
11 bankruptcy and the effect that such plans have on bankruptcy outcomes. Many per-
ceive that retention bonus plans simply transfer value from creditors to managers. The
perception that managers are enriching themselves through such plans while lower level
workers are laid off has generated immense controversy in the media and the Congress.
However, companies have defended the use of these plans by arguing that key employee
retention plans are important to dissuade mission-critical employees from leaving the firm.
We find that measures of creditor power, such as the presence of creditors’ committees
and debtor-in-possession financing, significantly increase the likelihood of a bankrupt firm
implementing retention and incentive bonus plans. Similarly, these plans are more likely
to be used when employees have increased outside employment options. Overall, the
evidence generated through our study suggests that KERPs are more likely to be used
31
when creditors have increased control over the bankruptcy process and when there is
a greater risk of employees leaving the firm. We do not find evidence that entrenched
incumbent CEOs are more likely to be covered by KERPs. On the contrary, turnaround
specialists hired to improve and reorganize troubled companies are more likely to be
covered by these plans.
Furthermore, we examine the effect of KERPs on bankruptcy outcomes and find that
it is important to distinguish between plans that provides only retention bonuses and
those that provide both retention and incentive bonuses. While KERPs, in general,
do not have material effect on a firm’s likelihood of emergence from bankruptcy, plans
that provide incentive bonuses significantly increase the likelihood of a firm’s emergence.
Furthermore, incentive plans significantly reduce the time a firm spends in bankruptcy
and the likelihood of absolute priority rule deviation.
The nature of such incentives matters. When incentive plans tie bonuses to a firm’s
emergence or provide incentive bonuses contingent on EBITDA targets at emergence, the
likelihood of emergence increases. On the contrary, when incentive bonuses are tied to
asset sales, it becomes more likely that firms will, in fact, sell their assets.
Overall, the evidence in this study casts doubt on claims that KERPs are adopted
because creditors are ineffective in preventing managers from enriching themselves through
the payment of these bonuses. On the contrary, we find that creditor control is critical
in the payment of retention and incentive bonuses and that such plans generally improve
outcomes for creditors.
32
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34
Table 1: Use of KERPs in Chapter 11
The table reports annual distribution of firms adopting key employee retention plans. Columns 3 to 5
provide annual distribution of three different types of KERPs – plans that provide only retention bonuses,
plans that provide both retention and incentive bonuses, and finally plans that provide only incentive
bonuses. The initial sample includes all Chapter 11 filings by public U.S. firms with book assets above
$100 million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcy cases that were
dismissed and those that were still pending as of December 31, 2008. We also exclude financial firms,
utilities, and firms headquartered outside the U.S. Year is the year in which of filing of Chapter 11.
KERPs Featuring
Year Total Adopted Retentions Retention IncentivesFilings KERP Only w/Incentives Only
(1) (2) (3) (4) (5)
1996 14 (3.4%) 4 (29%) 3 (21%) 1 (7%) 0 (0%)1997 13 (3.1%) 5 (38%) 3 (23%) 0 (0%) 2 (15%)1998 24 (5.8%) 6 (25%) 5 (21%) 1 (4%) 0 (0%)1999 36 (8.6%) 15 (42%) 8 (22%) 7 (19%) 0 (0%)2000 72 (17.3%) 22 (31%) 9 (13%) 13 (18%) 0 (0%)2001 82 (19.7%) 30 (37%) 11 (13%) 18 (22%) 1 (1%)2002 67 (16.1%) 25 (37%) 10 (15%) 15 (22%) 0 (0%)2003 45 (10.8%) 23 (51%) 6 (13%) 10 (22%) 7 (16%)2004 27 (6.5%) 15 (56%) 7 (26%) 7 (26%) 1 (4%)2005 19 (4.6%) 10 (53%) 5 (26%) 5 (26%) 0 (0%)2006 11 (2.6%) 6 (55%) 0 (0%) 1 (9%) 5 (45%)2007 7 (1.7%) 3 (43%) 0 (0%) 0 (0%) 3 (43%)
Total 417 (100.0%) 164 (39%) 67 (16%) 78 (19%) 19 (5%)
35
Table 2: Summary Statistics
The table presents summary statistics of our sample firms. Panel A presents mean and medianvalues of firm characteristics in the year before bankruptcy. Panel B provides summary statistics ofbankruptcy-related variables. Panel C summarizes governance and CEO characteristics, while panelD tabulates bankruptcy outcomes and presents means and medians of time to resolution in monthsfor each of the three outcomes. The initial sample includes all Chapter 11 filings by U.S. publicfirms with book assets above $100 million (in constant 1980 dollars) from 1996 to 2007. We excludebankruptcy cases that were dismissed and those that were still pending as of December 31, 2008.We also exclude financial firms, utilities, and firms headquartered outside the U.S. The financial andownership data are as of the year before the filing. The variables are defined in Appendix Table 1.
Variable N Mean Median
Panel A: Firm Characteristics
Assets (in millions of 2008 dollars) 417 2040.36 661.81Leverage 417 1.02 0.92Industry-adjusted leverage 417 0.44 0.36EBITDA-to-assets 416 0.01 0.05Industry-adjusted EBITDA-to-assets 416 -0.07 -0.05Secured debt/assets 410 0.42 0.39Institutional ownership 417 0.27 0.23
Panel B: Bankruptcy Characteristics
Pre-packaged 417 0.29Delaware 417 0.44DIP financing 417 0.67Creditors’ committee 417 0.85Equity committee 417 0.11APRDev 417 0.17
Panel C: Governance and CEO Characteristics
Board independence 392 0.71 0.75Board size 392 7.67 7.00CEO-chairman 393 0.50 1.00CEO-founder 390 0.15 0.00CEO age 370 53.05 53.00CEO tenure 402 4.00 2.00CEO incumbent 405 0.41 0.00CEO internal hire 404 0.24 0.00CEO external hire 404 0.35 0.00CEO turnaround specialist 404 0.12 0.00
Panel D: Bankruptcy Outcomes
Bankruptcy duration (in months)
Outcome N (%) Mean Median
Reorganization 249 (59.7%) 13.58 10.23Acquisition 46 (11.0%) 18.06 18.10Liquidation 122 (29.3%) 23.72 16.88
Total 417 (100.0%) 17.04 13.53
36
Table 3: Details of KERPs
The table reports mean and median values of employee coverage of retention and incentive plans, the
bonuses paid under these plans, aggregate plan costs, and plan objectives for retention and incentive
plans. The initial sample includes all Chapter 11 filings by U.S public firms with book assets above $100
million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcy cases that were dismissed
and those that were still pending as of December 31, 2008. We also exclude financial firms, utilities, and
firms headquartered outside the U.S. The variables are defined in Appendix Table 1.
Retention Plans Incentive Plans
Plan Features N Mean Median N Mean Median
# of key employees in the plan 126 456.13 81.50 74 245.95 44.50# of key employees/total employees 126 0.06 0.02 74 0.05 0.01# of tier groups 109 3.89 3.00 69 3.30 3.00Key employees: highest-tier group 91 21.87 6.00 51 12.90 3.00Key employees: lowest-tier group 76 157.14 46.00 33 95.64 17.00Bonus (% of salary): highest-tier group 111 82.81 75.00 52 113.18 95.00Bonus (% of salary): lowest-tier group 91 34.17 30.00 39 31.21 25.00Plan includes CEO 142 0.79 1.00 96 0.81 1.00Plan includes non-CEO executives 142 0.99 1.00 97 0.95 1.00Plan includes other employees 142 0.86 1.00 97 0.72 1.00
Retention plan objectives:
Retention plan: minimum stay 124 0.85 1.00Minimum months of stay required 95 9.20 8.00Retention plan: plan confirmation 124 0.52 1.00
Incentive plan objectives:
Objective: emergence 97 0.48Objective: EBITDA 97 0.46Objective: asset sale 97 0.30Objective: enterprise value 97 0.19Objective: speed 97 0.13Objective: recovery 97 0.13
Plan Costs:
Total costs (in 2008 $ mill) 130 8.53 4.06 79 7.25 3.87Total costs/assets (%) 130 0.44 0.37 79 0.39 0.24Maximum pool (in 2008 $ mill) 120 9.45 4.69 68 16.11 4.15Maximum pool/assets (%) 120 0.50 0.44 68 0.64 0.32
37
Tab
le4:
Log
itM
odel
sof
KE
RP
Adop
tion
inC
hap
ter
11F
irm
s
Th
eta
ble
pre
sents
the
logi
tes
tim
ates
from
mod
els
that
rela
teK
ER
Ps
tom
easu
res
of
cred
itor
pow
eran
dem
plo
yees
’ou
tsid
eop
tion
s.T
he
init
ial
sam
ple
incl
ud
esal
lC
hap
ter
11fi
lin
gsby
U.S
.p
ub
lic
firm
sw
ith
book
ass
ets
ab
ove
$100
mil
lion
(in
con
stant
1980
doll
ars
)fr
om
1996
to2007.
We
excl
ud
eb
ankru
ptc
yca
ses
that
wer
ed
ism
isse
dan
dth
ose
that
wer
est
ill
pen
din
gas
of
Dec
emb
er31,
2008.
We
als
oex
clu
de
fin
an
cial
firm
s,u
tili
ties
,an
dfi
rms
hea
dqu
arte
red
outs
ide
the
U.S
.T
he
vari
ab
les
are
defi
ned
inA
pp
end
ixT
ab
le1.
All
regre
ssio
ns
contr
ol
for
Fam
a-F
ren
ch12
-in
du
stry
fixed
effec
ts.
Nu
mb
ers
inp
aren
thes
esare
z-va
lues
.∗∗∗ ,∗∗
an
d∗
den
ote
sign
ifica
nce
at
the
1%
,5%
,an
d10%
leve
ls,
resp
ecti
vely
.
(1)
(2)
(3)
(4)
(5)
(6)
Ln
(ass
ets)
0.46
5∗∗∗
0.4
50∗∗∗
0.5
29∗∗∗
0.4
75∗∗∗
0.4
06∗∗∗
0.3
43∗∗
(3.7
)(3
.5)
(3.9
)(3
.7)
(2.8
)(2
.2)
Pre
-pac
kage
d-0
.861∗∗∗
-1.0
30∗∗∗
-0.8
92∗∗∗
-0.9
73∗∗∗
-0.8
84∗∗∗
-0.8
29∗∗
(-2.
8)(-
3.2
)(-
2.7
)(-
3.0
)(-
2.7
)(-
2.3
)
Del
awar
e0.
215
0.2
34
0.3
15
0.1
71
0.3
28
0.3
84
(0.9
)(1
.0)
(1.3
)(0
.7)
(1.3
)(1
.4)
Cre
dit
ors’
com
mit
tee
2.21
9∗∗∗
2.2
42∗∗∗
2.2
76∗∗∗
2.1
46∗∗∗
2.3
59∗∗∗
2.2
66∗∗∗
(3.5
)(3
.4)
(3.4
)(3
.3)
(3.5
)(3
.3)
DIP
fin
anci
ng
1.19
2∗∗∗
1.2
82∗∗∗
1.2
36∗∗∗
1.1
82∗∗∗
1.2
70∗∗∗
1.2
22∗∗∗
(4.2
)(4
.4)
(4.0
)(3
.9)
(4.1
)(3
.5)
Ind
ust
ryin
dis
tres
s-0
.592
-0.6
06
-0.5
67
-0.5
71
-0.5
41
(-1.6
)(-
1.6
)(-
1.5
)(-
1.5
)(-
1.3
)
ThickEmplM
arkets
1.3
88∗∗∗
1.3
91∗∗∗
1.2
60∗∗∗
1.3
80∗∗∗
1.2
27∗∗
(3.2
)(3
.0)
(2.7
)(3
.0)
(2.3
)
IndCom
pGrowth
1.531∗∗
1.4
61∗
1.7
57∗∗
1.4
64∗
1.2
60
(2.0
)(1
.9)
(2.2
)(1
.9)
(1.5
)
Boa
rdin
dep
end
ence
0.0
91
-0.0
64
(0.1
)(-
0.1
)
CE
O-c
hai
rman
-0.1
53
0.1
48
(-0.6
)(0
.5)
Boa
rdsi
ze0.1
11∗∗
0.1
41∗∗
(2.1
)(2
.2)
38
Tab
le4
Con
tinued
(1)
(2)
(3)
(4)
(5)
(6)
CE
Oag
e≥
600.0
72
(0.2
)
CE
Ote
nure
0.0
04
(0.1
)
CE
O-f
oun
der
0.5
95
(1.5
)
CE
Oin
tern
alh
ire
0.0
33
(0.1
)
CE
Oex
tern
alh
ire
-0.3
41
(-0.8
)
CE
Otu
rnar
oun
dsp
ecia
list
0.5
52
(1.1
)
Constant
-6.1
32∗∗∗
-6.1
07∗∗∗
-6.6
21∗∗∗
-5.9
30∗∗∗
-6.6
54∗∗∗
-6.7
05∗∗∗
(-5.
6)(-
5.5
)(-
5.3
)(-
5.2
)(-
5.6
)(-
4.9
)
Pse
ud
oR
20.
190.2
20.2
20.2
20.2
30.2
1
Observations
417
415
390
392
390
346
39
Table 5: Multinomial Logit Models of Retention-Only Plans and Incentive Bonus Plans
This table reports results from multinomial logit regressions for the adoption of bonus plans. The referencecategory is the set of firms without KERPs. The alternative categories are firms that use bonus plansthat only pay retention bonuses and those that pay incentive bonuses (either with retention bonusesor without). The initial sample includes all Chapter 11 filings by U.S. public firms with book assetsabove $100 million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcy cases that weredismissed and those that were still pending as of December 31, 2008. We also exclude financial firms,utilities, and firms headquartered outside the U.S. The variables are defined in Appendix Table 1. Allregressions control for Fama-French 12-industry fixed effects. Numbers in parentheses are z-values. ∗∗∗,∗∗ and ∗ denote significance at the 1%, 5%, and 10% levels, respectively.
(1) (2) (3) (4)
Retention-Only Bonus Plans
Ln(assets) 0.341∗∗ 0.421∗∗ 0.364∗∗ 0.353∗
(2.2) (2.6) (2.3) (1.9)
Pre-packaged -0.744∗ -0.672 -0.682∗ -0.640(-1.9) (-1.6) (-1.7) (-1.5)
Delaware 0.333 0.392 0.199 0.397(1.1) (1.2) (0.6) (1.2)
Creditors’ committee 20.586∗∗∗ 20.644∗∗∗ 20.544∗∗∗ 20.679∗∗∗
(17.8) (15.2) (17.4) (17.2)
DIP financing 0.698∗ 0.619∗ 0.611∗ 0.660∗
(1.9) (1.7) (1.7) (1.7)
Industry in distress -0.335 -0.360 -0.308 -0.319(-0.7) (-0.7) (-0.6) (-0.6)
ThickEmplMarkets 1.823∗∗∗ 1.712∗∗∗ 1.614∗∗∗ 1.678∗∗∗
(3.4) (2.9) (2.9) (2.9)
IndCompGrowth 0.555 0.385 0.619 0.313(0.6) (0.4) (0.6) (0.3)
Board independence 0.817(0.8)
CEO-chairman 0.049
(0.2)
Board size 0.069(1.0)
Plans with Incentive Bonuses
Ln(assets) 0.517∗∗∗ 0.614∗∗∗ 0.549∗∗∗ 0.453∗∗∗
(3.6) (4.0) (3.7) (2.8)
Pre-packaged -1.297∗∗∗ -1.074∗∗ -1.255∗∗∗ -1.110∗∗
(-3.1) (-2.5) (-3.0) (-2.6)
40
Table 5 Continued
(1) (2) (3) (4)
Delaware 0.162 0.249 0.144 0.281(0.6) (0.8) (0.5) (0.9)
Creditors’ committee 1.380∗∗ 1.428∗∗ 1.271∗ 1.550∗∗
(2.0) (2.0) (1.8) (2.2)
DIP financing 1.895∗∗∗ 1.906∗∗∗ 1.813∗∗∗ 1.913∗∗∗
(4.6) (4.4) (4.2) (4.4)
Industry in distress -0.808∗ -0.837∗ -0.814∗ -0.792∗
(-1.7) (-1.8) (-1.7) (-1.7)
ThickEmplMarkets 1.168∗∗ 1.272∗∗ 1.059∗∗ 1.253∗∗
(2.3) (2.3) (2.0) (2.3)
IndCompGrowth 2.420∗∗∗ 2.477∗∗∗ 2.805∗∗∗ 2.514∗∗∗
(2.6) (2.7) (3.0) (2.7)
Board independence -0.625(-0.7)
CEO-chairman -0.327(-1.1)
Board size 0.127∗∗
(2.1)
Constant -6.642∗∗∗ -6.913∗∗∗ -6.479∗∗∗ -7.321∗∗∗
(-5.3) (-4.9) (-5.0) (-5.5)
Pseudo R2 0.21 0.21 0.20 0.22
Observations 415 390 392 390
41
Tab
le6:
Tob
itE
stim
ates
ofK
ER
PF
eatu
res
Th
eta
ble
pre
sents
the
tob
ites
tim
ates
from
mod
els
that
rela
teth
eK
ER
Pp
lan
featu
res
tofi
rman
db
an
kru
ptc
ych
ara
cter
isti
cs.
Th
ein
itia
lsa
mp
lein
clu
des
all
Ch
apte
r11
fili
ngs
by
U.S
pu
bli
cfi
rms
wit
hb
ook
ass
ets
ab
ove
$100
mil
lion
(in
con
stant
1980
doll
ars
)fr
om
1996
to2007.
We
excl
ud
eb
ankru
ptc
yca
ses
that
wer
ed
ism
isse
dan
dth
ose
that
wer
est
ill
pen
din
gas
of
Dec
emb
er31,
2008.
We
als
oex
clu
de
fin
an
cial
firm
s,u
tili
ties
,an
dfi
rms
hea
dqu
arte
red
outs
ide
the
U.S
.T
he
vari
ab
les
are
defi
ned
inA
pp
end
ixT
ab
le1.
All
regre
ssio
ns
contr
ol
for
Fam
a-F
ren
ch12
-in
du
stry
fixed
effec
ts.
Nu
mb
ers
inp
aren
thes
esare
z-va
lues
.∗∗∗ ,∗∗
an
d∗
den
ote
sign
ifica
nce
at
the
1%
,5%
,an
d10%
leve
ls,
resp
ecti
vely
.
Key
pla
nem
plo
yees
/B
onu
s(%
Sal
ary)
Pla
nC
ost
/A
sset
s(%
)M
ax
Pool/
Ass
ets
(%)
Key
pla
nem
plo
yees
/B
onu
s(%
of
Sala
ry)
Pla
nC
ost
/A
sset
s(%
)M
ax
Pool/
Ass
ets
(%)
Tot
alem
plo
yees
Hig
hes
tti
erT
ota
lem
plo
yees
Hig
hes
tti
er
Ret
enti
on
Bonu
ses
Ince
nti
ve
Bonu
ses
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
Ln
(ass
ets)
0.03
2∗∗∗
29.2
26∗∗∗
0.1
07∗∗∗
0.1
02∗∗
0.0
31∗∗
34.4
09∗
0.1
24∗∗
0.4
05∗∗∗
(3.3
)(3
.9)
(2.7
)(2
.3)
(2.5
)(1
.8)
(2.3
)(2
.8)
Pre
-pac
kage
d-0
.034
-46.
599∗∗
-0.2
90∗∗
-0.3
39∗∗∗
-0.0
43
-54.7
54
-0.3
02∗
-0.9
18∗∗
(-1.
3)(-
2.3)
(-2.6
)(-
2.7
)(-
1.2
)(-
1.0
)(-
1.9
)(-
2.1
)
Del
aware
0.03
117
.709
0.0
70
0.1
55∗
0.0
33
-13.6
91
0.1
29
0.5
39∗
(1.6
)(1
.2)
(0.8
)(1
.7)
(1.3
)(-
0.3
)(1
.2)
(1.8
)
Cre
dit
ors’
com
mit
tee
0.18
7∗∗∗
130.
867∗∗∗
0.6
74∗∗∗
0.9
85∗∗∗
0.1
23∗∗
103.6
65
0.2
45
0.8
41
(3.5
)(3
.1)
(3.2
)(3
.4)
(2.0
)(1
.2)
(1.1
)(1
.2)
DIP
fin
anci
ng
0.08
0∗∗∗
58.8
35∗∗∗
0.3
04∗∗∗
0.3
14∗∗∗
0.1
20∗∗∗
231.5
34∗∗∗
0.5
54∗∗∗
1.2
38∗∗∗
(3.1
)(3
.1)
(2.9
)(2
.7)
(3.3
)(3
.3)
(3.6
)(2
.9)
ThickEmplM
arkets
0.07
8∗∗
60.6
36∗∗
0.3
57∗∗
0.3
91∗∗
0.0
37
58.0
08
0.1
15
0.2
16
(2.3
)(2
.2)
(2.4
)(2
.4)
(0.9
)(0
.8)
(0.6
)(0
.4)
IndCom
pGrowth
0.04
247
.099
0.1
02
0.2
87
0.1
61∗∗
215.0
13∗
0.6
29∗
1.6
52∗
(0.7
)(1
.0)
(0.4
)(1
.0)
(2.1
)(1
.7)
(1.9
)(1
.8)
Ind
ust
ryin
dis
tres
s0.
000
-7.1
78-0
.144
-0.1
25
-0.0
42
0.2
80
-0.2
14
-0.5
73
(0.0
)(-
0.3)
(-1.1
)(-
0.9
)(-
1.0
)(0
.0)
(-1.2
)(-
1.2
)
Constant
-0.5
02∗∗∗
-383
.245∗∗∗
-1.5
80∗∗∗
-1.9
35∗∗∗
-0.5
17∗∗∗
-753.8
81∗∗∗
-1.9
62∗∗∗
-5.9
11∗∗∗
(-5.
4)(-
5.3)
(-4.2
)(-
4.3
)(-
4.5
)(-
4.0
)(-
4.1
)(-
4.5
)
Pse
ud
oR
20.
580.
060.1
50.1
60.3
60.0
50.1
30.1
2Observations
396
379
400
390
392
368
397
386
42
Tab
le7:
CE
OP
arti
cipat
ion
inK
ER
Ps
Th
eta
ble
pre
sents
logi
tes
tim
ates
from
regr
essi
ons
that
pre
dic
tth
ep
art
icip
ati
on
of
CE
Os
inK
ER
Ps
as
afu
nct
ion
of
CE
Och
ara
cter
isti
cs,
gove
rnan
ceva
riab
les,
firm
and
ban
kru
ptc
ych
aract
eris
tics
.T
he
init
ial
sam
ple
incl
ud
esall
Ch
ap
ter
11
fili
ngs
by
U.S
.pu
bli
cfi
rms
wit
hb
ook
asse
tsab
ove
$100
mil
lion
(in
con
stan
t19
80d
olla
rs)
from
1996
to2007.
We
excl
ud
eb
an
kru
ptc
yca
ses
that
wer
ed
ism
isse
dan
dth
ose
that
wer
est
ill
pen
din
gas
ofD
ecem
ber
31,
2008
.W
eal
soex
clu
de
fin
an
cial
firm
s,u
tili
ties
,an
dfi
rms
hea
dqu
art
ered
ou
tsid
eth
eU
.S.
Th
eva
riab
les
are
defi
ned
inA
pp
end
ixT
able
1.A
llre
gres
sion
sco
ntr
ol
for
Fam
a-F
ren
ch12-i
nd
ust
ryfi
xed
effec
ts.
Nu
mb
ers
inp
are
nth
eses
are
z-va
lues
.∗∗∗ ,∗∗
and∗
den
ote
sign
ifica
nce
atth
e1%
,5%
,an
d10
%le
vels
,re
spec
tive
ly.
CE
OP
art
icip
ati
on
inK
ER
Ps
CE
OP
art
icip
ati
on
inIn
centi
ve
Pla
ns
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
CE
Oag
e≥
60-0
.217
-0.2
94
-0.2
82
-0.2
23
-0.6
77
-0.7
68∗
-0.7
17
-0.8
89∗
(-0.
7)(-
0.9)
(-0.8
)(-
0.6
)(-
1.6
)(-
1.7
)(-
1.6
)(-
1.8
)C
EO
tenure
0.02
50.
026
0.0
31
0.0
27
0.0
07
0.0
10
0.0
18
0.0
17
(0.9
)(0
.9)
(1.1
)(0
.8)
(0.2
)(0
.3)
(0.5
)(0
.4)
CE
O-f
oun
der
0.03
40.
045
0.1
51
0.3
43
0.3
020.2
88
0.4
37
0.7
83
(0.1
)(0
.1)
(0.4
)(0
.8)
(0.7
)(0
.7)
(1.0
)(1
.6)
CE
Oin
cum
ben
t-0
.161
-0.0
56
(-0.
5)(-
0.1
)C
EO
inte
rnal
hir
e0.
256
0.2
64
0.3
38
0.3
10
0.2
49
0.3
60
(0.7
)(0
.7)
(0.8
)(0
.7)
(0.6
)(0
.7)
CE
Oex
tern
alh
ire
-0.2
18
-0.1
83
-0.3
38
-0.4
30
-0.3
25
-0.5
81
(-0.
6)
(-0.5
)(-
0.8
)(-
0.9
)(-
0.7
)(-
1.0
)C
EO
turn
arou
nd
spec
iali
st0.
905∗∗
0.8
36∗
0.5
65
0.7
90
0.5
45
0.2
33
(2.1
)(1
.9)
(1.2
)(1
.4)
(0.9
)(0
.4)
Boa
rdsi
ze0.1
61∗∗∗
0.1
34∗∗
0.1
78∗∗∗
0.1
13
(3.0
)(2
.0)
(2.9
)(1
.6)
Boa
rdin
dep
end
ence
0.8
42
0.8
51
-0.3
48
-0.8
02
(1.0
)(0
.9)
(-0.4
)(-
0.7
)C
EO
-ch
airm
an0.3
59
0.1
27
0.1
26
-0.2
58
(1.3
)(0
.4)
(0.4
)(-
0.7
)L
n(a
sset
s)0.2
26
0.4
38∗∗
(1.5
)(2
.5)
Pre
pac
kage
d-0
.600∗
-0.6
84
(-1.7
)(-
1.4
)D
elaw
are
0.3
57
0.4
49
(1.3
)(1
.3)
Cre
dit
ors’
com
mit
tee
2.0
08∗∗∗
1.2
94
(3.0
)(1
.5)
DIP
fin
anci
ng
0.9
60∗∗∗
1.7
20∗∗∗
(2.7
)(3
.1)
43
Tab
le7
Con
tinued
CE
OP
arti
cip
ati
on
inK
ER
Ps
CE
OP
art
icip
ati
on
inIn
centi
veP
lan
s
(1)
(2)
(3)
(4)
(5)
(6)
(7)
(8)
ThickEmplM
arkets
0.4
20
0.2
73
(0.8
)(0
.4)
IndCom
pGrowth
0.6
03
2.2
97∗∗
(0.7
)(2
.1)
Ind
ust
ryin
dis
tres
s-0
.029
-0.2
61
(-0.1
)(-
0.5
)
Constant
-0.4
21-0
.545
-2.5
98∗∗∗
-6.3
27∗∗∗
-1.0
82∗∗
-1.0
77∗∗
-2.3
57∗∗
-6.7
93∗∗∗
(-1.
0)(-
1.2)
(-3.2
)(-
4.7
)(-
2.3
)(-
2.1
)(-
2.4
)(-
4.2
)
Pse
ud
oR
20.
030.
030.0
70.1
80.0
40.0
60.0
80.2
2
Observations
354
354
345
344
355
355
346
345
44
Tab
le8:
Eff
ect
ofR
eten
tion
and
Ince
nti
veP
lans
onB
ankru
ptc
yO
utc
omes
Th
eta
ble
exam
ines
the
effec
tof
rete
nti
onon
lyp
lan
son
emer
gen
cefr
om
ban
kru
ptc
y,d
ura
tion
of
ban
kru
ptc
y,an
dab
solu
tep
riori
tyru
led
evia
tion
.C
olu
mn
s(1
)an
d(3
)p
rese
nt
resu
lts
from
biv
ari
ate
pro
bit
regre
ssio
ns
of
reorg
an
izin
gin
ban
kru
ptc
y.C
olu
mn
s(2
)an
d(5
)p
rese
nt
resu
lts
from
trea
tmen
tre
gres
sion
sof
the
log
ofd
ura
tion
.F
inall
y,C
olu
mn
s(4
)an
d(6
)p
rese
nt
resu
lts
from
biv
ari
ate
pro
bit
regre
ssio
ns
of
AP
Rvio
lati
ons.
Th
ein
itia
lsa
mp
lein
clu
des
all
Ch
ap
ter
11
fili
ngs
by
U.S
pu
bli
cfi
rms
wit
hb
ook
ass
ets
ab
ove
$100
mil
lion
(in
con
stant
1980
dol
lars
)fr
om19
96to
2007
.W
eex
clu
de
ban
kru
ptc
yca
ses
that
wer
ed
ism
isse
dan
dth
ose
that
wer
est
ill
pen
din
gas
of
Dec
emb
er31,
2008.
We
also
excl
ud
efi
nan
cial
firm
s,u
tili
ties
,an
dfi
rms
hea
dqu
art
ered
ou
tsid
eth
eU
.S.
Th
eva
riab
les
are
defi
ned
inA
pp
end
ixT
ab
le1.
All
regre
ssio
ns
contr
olfo
rF
ama-
Fre
nch
12-i
nd
ust
ryfi
xed
effec
ts.
Nu
mb
ers
inp
are
nth
eses
are
z-va
lues
.∗∗∗ ,∗∗
an
d∗
den
ote
sign
ifica
nce
at
the
1%
,5%
,an
d10
%le
vel
s,re
spec
tive
ly.
Em
erge
nce
Du
rati
on
APRDev
Em
ergen
ceD
ura
tion
APRDev
(1)
(2)
(3)
(4)
(5)
(6)
KE
RP
1.02
8-0
.175
-0.4
99
(1.3
)(-
0.4
)(-
0.5
)
Ince
nti
ve1.6
75∗∗∗
-0.6
43∗∗∗
-1.9
95∗∗∗
(15.2
)(-
3.1
)(-
11.1
)
Cre
dit
ors’
com
mit
tee
-0.5
340.7
41∗∗∗
-0.2
30
-0.4
36∗
0.7
46∗∗∗
-0.0
55
(-1.
5)(4
.9)
(-0.8
)(-
1.8
)(6
.2)
(-0.3
)
DIP
fin
anci
ng
-0.0
10-0
.012
-0.1
48
-0.1
75
0.0
63
0.2
45
(-0.
0)(-
0.1
)(-
0.6
)(-
1.1
)(0
.7)
(1.4
)
Ln
(ass
ets)
0.10
70.0
59
0.1
58
0.0
35
0.0
84∗∗
0.2
07∗∗∗
(0.9
)(1
.2)
(1.3
)(0
.5)
(2.0
)(2
.8)
Ind
ust
ry-a
dju
sted
leve
rage
0.62
9∗∗
-0.1
10
0.0
71
0.4
69∗∗∗
-0.0
81
0.1
93
(2.2
)(-
1.2
)(0
.3)
(2.6
)(-
0.9
)(1
.1)
Ind
ust
ry-a
dju
sted
RO
A-0
.134
0.0
64
0.0
14
-0.1
06
0.1
11
0.4
18
(-0.
3)(0
.3)
(0.0
)(-
0.3
)(0
.6)
(0.8
)
Pre
-pac
kage
d1.
406∗∗∗
-1.0
48∗∗∗
1.2
02∗∗∗
1.2
93∗∗∗
-1.1
17∗∗∗
0.4
69∗∗∗
(6.8
)(-
8.4
)(4
.8)
(7.0
)(-
10.9
)(2
.7)
Del
awar
e-0
.351∗∗
-0.0
62
0.1
25
-0.2
73∗∗
-0.0
54
0.1
18
(-2.
4)(-
0.8
)(0
.7)
(-2.1
)(-
0.7
)(0
.8)
Sec
ure
dd
ebt/
asse
ts0.
311
-0.1
04
-0.3
36
0.318
-0.1
21
-0.1
71
(1.0
)(-
1.4
)(-
1.0
)(1
.3)
(-1.6
)(-
0.7
)
Inst
itu
tion
alow
ner
ship
0.00
30.1
00
0.4
00
-0.2
88
0.2
24
0.7
64∗∗
(0.0
)(0
.6)
(0.9
)(-
1.0
)(1
.3)
(2.5
)
45
Tab
le8
Con
tinued
Em
erge
nce
Du
rati
on
APRDev
Em
erge
nce
Du
rati
on
APRDev
(1)
(2)
(3)
(4)
(5)
(6)
Equ
ity
com
mit
tee
0.37
30.
223∗
0.3
89
0.3
50
0.1
95
0.1
66
(1.4
)(1
.9)
(1.4
)(1
.6)
(1.6
)(0
.7)
Ind
ust
ryin
dis
tres
s0.
125
0.0
87
-0.0
90
0.2
11
0.0
38
-0.3
03
(0.5
)(0
.8)
(-0.3
)(1
.1)
(0.3
)(-
1.4
)
Constant
-1.0
001.
962∗∗∗
-2.2
07∗∗∗
-0.4
51
1.8
31∗∗∗
-2.1
36∗∗∗
(-1.
1)(5
.6)
(-2.6
)(-
0.8
)(5
.9)
(-3.7
)
Wal
dχ2
210.
7∗∗∗
401.
2∗∗∗
158.1∗∗∗
297.4∗∗∗
367.0∗∗∗
185.9∗∗∗
Observations
408
408
408
408
408
408
46
Tab
le9:
Pla
nO
bje
ctiv
esan
dR
eorg
aniz
atio
nin
Ban
kru
ptc
y
Th
eta
ble
pre
sents
esti
mat
esfr
omlo
git
regr
essi
on
sth
at
exam
ine
the
effec
tof
spec
ific
pla
nob
ject
ives
on
the
like
lih
ood
of
afi
rm’s
emer
gen
cefr
omb
ankru
ptc
y.T
he
init
ial
sam
ple
incl
ud
esal
lC
hap
ter
11
fili
ngs
by
U.S
.p
ub
lic
firm
sw
ith
book
ass
ets
ab
ove
$100
mil
lion
(in
con
stant
1980
dol
lars
)fr
om19
96to
2007
.W
eex
clu
de
ban
kru
ptc
yca
ses
that
wer
ed
ism
isse
dan
dth
ose
that
wer
est
ill
pen
din
gas
of
Dec
emb
er31,
2008.
We
also
excl
ud
efi
nan
cial
firm
s,u
tili
ties
,an
dfi
rms
hea
dqu
art
ered
ou
tsid
eth
eU
.S.
Th
eva
riab
les
are
defi
ned
inA
pp
end
ixT
ab
le1.
All
regre
ssio
ns
contr
olfo
rF
ama-
Fre
nch
12-i
nd
ust
ryfi
xed
effec
ts.
Nu
mb
ers
inp
are
nth
eses
are
z-va
lues
.∗∗∗ ,∗∗
an
d∗
den
ote
sign
ifica
nce
at
the
1%
,5%
,an
d10
%le
vel
s,re
spec
tive
ly.
(1)
(2)
(3)
(4)
(5)
(6)
Ret
enti
onp
lan
:m
inim
um
stay
0.37
50.8
11∗∗
(1.2
)(2
.2)
Ret
enti
onp
lan
:p
lan
con
firm
atio
n-0
.004
-0.5
62
(-0.0
)(-
1.3
)
Ob
ject
ive:
emer
gen
ce1.1
82∗∗∗
1.5
77∗∗∗
(2.7
)(2
.6)
Ob
ject
ive:
asse
tsa
le-2
.459∗∗∗
-3.2
19∗∗∗
(-3.7
)(-
4.2
)
Ob
ject
ive:
EB
ITD
A0.8
28∗∗
1.0
83∗∗
(2.0
)(2
.1)
Cre
dit
ors’
com
mit
tee
-0.4
51-0
.385
-0.4
23
-0.2
69
-0.4
10
-0.4
47
(-0.
9)(-
0.8
)(-
0.9
)(-
0.5
)(-
0.8
)(-
0.9
)
DIP
fin
anci
ng
0.11
10.1
74
0.1
56
0.3
54
0.1
97
-0.0
15
(0.4
)(0
.6)
(0.5
)(1
.2)
(0.7
)(-
0.0
)
Ln
(ass
ets)
0.26
2∗0.3
06∗∗
0.2
86∗∗
0.3
10∗∗
0.3
04∗∗
0.1
57
(1.9
)(2
.2)
(2.2
)(2
.3)
(2.3
)(1
.1)
Ind
ust
ry-a
dju
sted
leve
rage
1.71
3∗∗∗
1.7
47∗∗∗
1.3
40∗∗∗
1.3
81∗∗∗
1.3
55∗∗∗
1.7
52∗∗∗
(3.7
)(3
.7)
(3.1
)(3
.2)
(3.2
)(3
.5)
Ind
ust
ry-a
dju
sted
RO
A0.
499
0.5
11
0.2
54
0.3
13
0.2
63
0.5
66
(0.8
)(0
.8)
(0.4
)(0
.5)
(0.4
)(0
.8)
Pre
-pac
kage
d2.
046∗∗∗
1.9
79∗∗∗
2.1
50∗∗∗
1.9
82∗∗∗
2.1
25∗∗∗
2.0
74∗∗∗
(5.3
)(5
.1)
(5.7
)(5
.2)
(5.6
)(5
.2)
Del
awar
e-0
.436∗
-0.4
24
-0.4
97∗
-0.4
79∗
-0.4
93∗
-0.4
58
(-1.
7)(-
1.6
)(-
2.0
)(-
1.9
)(-
2.0
)(-
1.6
)
Sec
ure
dd
ebt/
asse
ts1.
135∗
1.0
86∗
0.6
71
0.6
88
0.6
74
1.3
13∗∗
(1.9
)(1
.8)
(1.3
)(1
.3)
(1.3
)(2
.0)
47
Tab
le9
Con
tinued
(1)
(2)
(3)
(4)
(5)
(6)
Inst
itu
tion
alow
ner
ship
0.41
50.4
58
0.1
25
0.8
54
0.3
29
0.6
56
(0.8
)(0
.8)
(0.2
)(1
.5)
(0.6
)(1
.1)
Equ
ity
com
mit
tee
0.83
1∗
0.8
32∗
0.9
51∗∗
0.6
66
0.8
04∗
0.7
61
(1.8
)(1
.8)
(2.1
)(1
.5)
(1.8
)(1
.5)
Ind
ust
ryin
dis
tres
s0.
304
0.2
66
0.2
08
0.1
43
0.1
86
0.5
21
(0.8
)(0
.7)
(0.5
)(0
.4)
(0.5
)(1
.3)
Constant
-2.4
92∗∗
-2.7
13∗∗
-2.3
25∗∗
-2.6
67∗∗
-2.5
27∗∗
-1.8
65
(-2.
3)(-
2.5
)(-
2.2
)(-
2.5)
(-2.4
)(-
1.6
)
Pse
ud
oR
20.
260.2
60.2
60.2
80.2
50.3
4
Observations
391
391
410
410
410
391
48
Appendix Table 1: Variable Definitions and Data Sources
The table provides definition of key variables. Data sources for firm characteristics and post-emergenceperformance are BRD, BankruptcyData.com, Compustat, 10Ks, Execucomp, and Thomson Reuters Own-ership Database (13Fs). Data sources for firm characteristics are BRD, BankruptcyData.com, Factiva,8K filings, and bankruptcy plans. Details on KERPs are obtained from BankruptcyData.com, Factiva,PACER, Parcels Inc., and National Archives.
Variable Definition
Firm Characteristics
Assets Book value of assets (in 2008 dollars)Leverage Total liabilities to assets ratioEBITDA-to-assets Ratio of EBITDA to book assetsSecured debt/assets Ratio of secured debt to book assetsInstitutional ownership Institutional ownership (in %)Industry in distress 0-1 dummy varaible, =1 if the median stock return of same 2-digit
SIC industry is -30% or less in the year before a firm files for bankruptcy.ThickEmplMarkets 0-1 dummy variable, = 1 if there are 20 or more firms
in the same-2-digit industry and headquarteredwithin 100 km of the company in bankruptcy.
IndCompGrowth Industry median growth in salary and bonus of non-CEO executivesin the year before the Chapter 11 filing.
Bankruptcy Characteristics
Pre-packaged 0-1 dummy variable, = 1 if bankruptcy is prepackagedor prenegotiated
Delaware 0-1 dummy variable, = 1 if bankruptcy filed in DelawareDIP financing 0-1 dummy variable, =1 if debtor obtained DIP financingCreditors’ committee 0-1 dummy variable, = 1 if creditor committee appointedEquity committee 0-1 dummy variable, = 1 if equity committee appointedReorganization 0-1 dummy variable, = 1 if firm reorganized in Chapter 11Liquidation 0-1 dummy variable, = 1 if firm is liquidatedAcquisition 0-1 dummy variable, = 1 if firm is acquiredDuration Months in bankruptcy from filing to plan confirmationAPRDev 0-1 dummy variable, =1 if equity holder receive payoffs
before creditors are paid in full.
Governance and CEO Characteristics
Board independence 0-1 dummy variable, =1 if a majority of board members are independentBoard size Number of board membersCEO-chairman 0-1 dummy variable, =1 if CEO is also chairman of the boardCEO-founder 0-1 dummy variable, =1 if CEO is also the firm’s founderCEO age Age of CEOCEO tenure Tenure as CEO with the firmCEO incumbent 0-1 dummy variable, =1 if CEO has been with the firm from before filingCEO internal hire 0-1 dummy variable, =1 if the newly-hired CEO is hired internallyCEO external hire 0-1 dummy variable, =1 if the newly-hired CEO is hired externallyCEO turnaround specialist 0-1 dummy variable, =1 if the external hire is a turnaround specialist
49
Appendix Table 1 continued
Variable Definition
Key Employee Retention Plans
KERP 0-1 dummy variable, = 1 if retention/incentive plan approvedRetention 0-1 dummy variable, = 1 if firm offers retention bonusesIncentive 0-1 dummy variable, = 1 if firm offers incentive bonusesKey employees # key employees in planKey employees/total employees # of key employees/Total employeesTier groups Number of tier groupsEmployees: highest tier group # of employees in highest tier groupEmployees: lowest tier group # of employees in lowest tier groupRetention bonus-highest tier Bonus (as % of salary) in highest tier groupRetention bonus-lowest tier Bonus (as % of salary) in lowest tier groupCEO in retention plan CEO is included in the retention planNon-CEO execs in retention plan Senior execs (other than CEO) in the retention planOther managers in plan Other employees in the retention planMinimum months of stay Minimum months of stay required to receive bonusBonus on minimum stay Fraction of bonus paid on minimum stayBonus on plan confirmation Fraction of bonus paid on plan confirmation
Objectives in Retention Plans
Retention: min stay 0-1 dummy variable, = 1 if retention bonus tied to minimum stayRetention: plan confirmation 0-1 dummy variable, = 1 if retention bonus tied to plan confirmation.
Objectives in Incentive Plans
Objective: emergence 0-1 dummy variable, = 1 if objective is tied to reorganizationObjective: EBITDA 0-1 dummy variable, = 1 if objective is tied to EBITDAObjective: asset sale 0-1 dummy variable, = 1 if objective is asset saleObjective: enterprise value 0-1 dummy variable, = 1 if objective is tied to enterprise valueObjective: speed 0-1 dummy variable, = 1 if objective is tied to speed of restructuringObjective: debt recovery 0-1 dummy variable, = 1 if objective is debt recovery.
50
Appendix A. KERP Examples from Court Motions
and Approvals
Examples of key employee retention and incentive plans taken from court document (such as motionsand orders approving key employment retention or incentive plans for firms in Chapter 11)
RETENTION PLAN FOR STAYING WITH THE DEBTOR
Excerpts from “Order Granting Debtors’ Motion to Approve Key Employee Retention Plan” for KittyHawk, Inc. dated August 23, 2000 by the US Bankruptcy Court for the Northern District of Texas.
IT IS, THEREFORE, ORDERED AND DECREED that the Key Employee listed on Ex-hibit “A” who retain employment with Kitty Hawk, Inc. or a Successor to the earlier of theeffective date of a Plan of Reorganization or January 1, 2001, shall be paid a retention bonusequal to six (6) months salary, payable in six monthly instalments beginning on the earlierof the effective date of a plan of reorganization or January 1, 2001, if these cases remain inChapter 11. No bonus would be payable (and any unpaid bonus would be forfeited) if a KeyEmployee: (a) resigns, (b) is terminated for cause or (c) does not execute a covenant notto compete with the Debtors (or their successors under a plan of reorganization) throughDecember 31, 2001.
Excerpts from “Motion for an Order Pursuant to 11 U.S.C. 105(a) and 363(b) Authorizing the Debtorsto Implement a Key Employee Retention Plan” for Horizon PCS, Inc. dated August 22, 2003 by theUS Bankruptcy Court for the Northern District of Ohio.
The Debtors propose to provide stay bonuses (the “Stay Bonuses”) to the 45 Key Employeesthat the Debtors deem to be so critical to their operations that the loss of such employees’services would cost the Debtors more than the cost of the Stay Bonus and other benefitsprovided under the Retention Plan. The Debtors selected the 45 Key Employees basedon their skill sets and knowledge, which are essential to the operation of the Debtors’businesses during these Chapter 11 restructurings, and other factors such as the likelihoodof their leaving for other employment opportunities. The Stay bonus are designed to inducethe 45 Key Employees to remain in the Debtors’ employ through the pendency of thesechapter 11 cases, or for as long as the Debtors require their services.
The Stay Bonus will be earned by each of qualifying Key Employee in the amounts andtimes set forth below, and will be paid as soon as practicable thereafter.
A. 25% (the “First Payment”) on the 45th day after the Petition Date;
B. 25% (the “Second Payment”) on earlier of: (1) confirmation of a plan of reorganiza-tion, (2) a Court order approving sale of substantially all assets becoming final, and(3) 105 days after the First Payment;
C. 50% upon the earlier of: (1) consummation of a Qualifying Event and upon earlierof (a) involuntary termination of employment (in which case the employees will beentitled to the greater of the remaining Stay Bonus or his/her Severance Pay); and (b)90 days after consummation of Qualifying Event; and (2) 190 days after the SecondPayment.
Excerpts from “Motion of the Debtors Pursuant to Sections 363(b) and 105(a) of the Bankruptcy Codefor Authorization to Establish a Key Employee Retention Plan” filed by WorldCom Inc. dated October18, 2002 with the US Bankruptcy Court for the Southern District of New York.
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The Debtors have to date identified approximately 329 Key Employees who will participatein the Retention Plan. In developing the Retention Plan, the Debtors classified those KeyEmployees into four groups (each a “Group”) based on each employee’s role in the Companyand expected contribution to the reorganization efforts of the Debtors:
• Group 1 includes 4 Key Employees (the “Group 1 Employees”) who hold the most se-nior positions at WorldCom. None of these employees will participate in the RetentionPlan.
• Group 2 includes 25 Key Employees (the “Group 2 Employees”). The Stay Bonus foreach Group 2 Employee is equal to 65 % of the individual’s annual base compensation,subject to a cap of $125,000. The range of Stay Bonuses for Group 2 Employees isexpected to be from $90,000 to $125,000.
• Group 3 includes 90 Key Employees (the “Group 3 Employees”). The Stay Bonus foreach Group 3 Employee is equal to 50% of the individual’s annual base compensation,subject to a cap of $125,000. The range of Stay Bonuses for Group 3 Employees isexpected to be from $47,000 to $125,000.
• Group 4 includes approximately 210 Key Employees (the “Group 4 Employees”). TheStay Bonus for each Group 4 Employee is equal to 35% of the individual’s annual basecompensation, subject to a cap of $125,000. The range of Stay Bonuses for Group 4Employees is expected to be from $20,000 to $90,000.
The Retention Plan provides bonuses designed to encourage Key Employees to both remainemployed by the Debtors throughout the reorganization process and to work productivelyto ensure that the Debtors complete their reorganization in a timely and efficient manner.The Retention Plan provides for a stay bonus (the “Stay Bonus”) if the Key Employeeremains employed by the Debtors on specific target dates. The Stay Bonus for any KeyEmployee is equal to a percentage of the individual’s annual base compensation accordingto the classification of the Key Employee set forth below. The Debtors propose to pay theStay Bonuses pursuant to the following schedule:
• 25% of the Stay Bonus paid on December 1, 2002,
• 25% of the Stay Bonus paid on March 31, 2003, and
• 50% of the Stay Bonus paid 60 days after confirmation of a plan of reorganization.
In addition, the Retention Plan provides that each Key Employee who remains employed bythe Debtors on the date that a plan of reorganization is confirmed (the “Plan ConfirmationDate”) will receive an additional bonus amount equal to 10% of the Key Employee’s StayBonus (the “Plan Progress Bonus”). The Plan Progress Bonus would be earned if the PlanConfirmation Date occurs by December 2003. Should the Plan Confirmation Date occurearlier, the Plan Progress would increase as set forth on the schedule below:
• 100% of the Plan Progress Bonus if the Plan Confirmation Date occurs in December2003;
• 150% of the Plan Progress Bonus if the Plan Confirmation Date occurs in November2003;
• 200% of the Plan Progress Bonus if the Plan Confirmation Date occurs in October2003; and
• 250% of the Plan Progress Bonus if the Plan Confirmation Date occurs on or beforeSeptember 30, 2003.
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RETENTION BONUS TIED TO STAY AND INCENTIVE BONUS TIED TO EMER-GENCE
Excerpts from “Debtors’ Motion for an Order Pursuant to Section 363(a) and 105(a) of the BankruptcyCode Authorizing Implementation of Retention Plan” filed by Galey & Lord, Inc. on May 1, 2002with the US Bankruptcy Court for the Southern District of New York.
The Retention Program is designed to provide the Critical Employees with competitivefinancial incentives, among other things, (a) to remain in their current positions with theDebtors through the effective date (the “Emergence”) of a plan or plans of reorganization inthese cases, (b) to assume the additional administrative and operational burdens imposedon the Debtors by these cases, and (c) to use their best efforts to improve the Debtors’financial performance and facilitate the Debtors’ successful reorganization.
The Retention Program includes six separate components: (a) a performance incentive plandesigned to provide performance incentives to key management employees; (b) a stay bonusplan designed to ensure the continued employment of certain key management through thecompletion of the Debtors’ restructuring; (c) an emergence bonus plan designed to providean additional incentive to the Debtors’ CEO, who is particularly essential to the implemen-tation of the Debtors’ restructuring plan, through the confirmation process; (d) a severanceplan designed to ensure basic job protection for key management employees terminated otherthan for cause; (e) a discretionary transition payment plan designed to provide managementwith the ability to offer incentives to certain employees during a transition period at theend of which such employees would be terminated, in the event such circumstances arise;and (f) a discretionary retention pool designed to provide the CEO discretionary authorityto offer incentives to employees (including new employees) not otherwise participating inthe Stay Bonus Plan or the Emergence Bonus Plan.
RETENTION BONUS TIED TO PLAN CONFIRMATION AND INCENTIVE BONUSTIED TO ASSET SALE, EMERGENCE, AND DEBT RECOVERY
Excerpts from “Debtors’ Motion for an Order under 11 U.S.C. Section 105 and 363 Authorizing Imple-mentation of Key Employee Severance/Retention Program” filed by SLI, Inc. on October 3, 2002 withthe US Bankruptcy Court for the District of Delaware.
The Severance/Retention Program is a three-tier program that provides certain key em-ployees or their successors (the “Key Employees”) with an opportunity to receive a re-tention/stay bonus (the “Retention Payment”) and a severance payment (the “SeverancePayment”).
• Tier One Key Employee. The first tier (“Tier One”) covers a single employee, the ChiefExecutive Officer (the “CEO”) who has been designated as a corporate employee.Under the program, the Tier One employee would receive a retention payment of$350,000 and would be entitled to a severance payment of $150,000. The Tier Oneemployee’s Retention Payment shall be earned, due and payable in the followingmanner and on the earliest of the following events: (i) payment in full on terminationof the Tier One employee’s employment by the company ”without cause”; (ii) paymentin full on consummation of a plan of reorganization; or (iii) payment of 50% onconsummation of a sale of substantially all of the Debtors’ assets pursuant to 11 U.S.C.Section 363 in the GLE business line or the ML business line and the remaining 50%on consummation of a sale of the remaining business line or consummation of a planof reorganization. In addition to the Retention and Severance Payments, the TierOne employee would also be eligible to receive incentive compensation in an amount
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not to exceed $1.2 million. This additional Incentive compensation is earned basedupon the prepetition lenders’ aggregate percentage recovery. Receipt of the IncentiveCompensation would thus be directly tied to the amount of proceeds generated byone or more sales of assets of the Debtors’ respective business lines or distributionsunder a reorganization plan.
• Tier Two Key Employee. The second tier of the Severance/Retention program (“TierTwo”) covers twenty (20) employees or positions within the Debtors’ Corporate, ML,GLE and GLA business lines. Retention and Severance Payments to Tier Two employ-ees are based on position and are calculated as a percentage of a Tier Two employee’scurrent base salary. With respect to the Retention Payments, certain members ofthe Debtors’ executive management, including the Chief Financial Officer and theExecutive Vice Presidents, are eligible to receive payments ranging from 75% to 150%of base salary. Retention Payment shall be earned, due and payable in the followingmanner and on the earliest of the following events: (i) payment in full on termina-tion of the Tier One employee’s employment by the company ”without cause”; (ii)payment in full on consummation of a plan of reorganization; or (iii) payment of 50%on consummation of a sale of substantially all of the Debtors’ assets pursuant to 11U.S.C. Section 363 in the GLE business line or the ML business line and the remaining50% on consummation of a sale of the remaining business line or consummation of aplan of reorganization.
• Tier Three Key Employee. The third tier (“Tier Three”) of the severance/RetentionProgram provides for a discretionary pool of $50,000 to be reserved for certain essentialstaff members, which total includes any and all payments to such persons on accountof Retention and Severance Payments.
RETENTION BONUS TIED TO MINIMUM STAY AND INCENTIVE BONUS TIEDTO EMERGENCE, ASSET SALES, AND ENTERPRISE VALUE
Excerpts from the “Motion for Entry of Order Authorizing the Debtor to Implement and Honor a KeyEmployee Retention Program and Approve Severance and Separation Plans” filed by Anchor GlassContainer Corporation on October 25, 2005 with the US Bankruptcy Court for the Middle Districtof Florida.
The Debtor seeks to enter into retention agreements (the ”Retention Agreements”) with 81Key Employees (including the CEO) to retain the Key Employees and ultimately maximizethe value of the Debtor’s assets for the benefit of all parties in interest. Specifically, theDebtor seeks to minimize the turnover of Key Employees by providing incentives for thesepeople to remain in the Debtor’s employ and work toward a successful reorganization of theDebtor.
For 80 of the 81 proposed participants in the Retention Program, the retention incentiveconsists of cash retention payments at a percentage of base salary ranging from 20% to 65%the participants’ base pay payable at various critical points in the Debtor’s Chapter 11 case.The timing of these retention payments is contemplated as follows:
Tier # of % of Court 2/15/06 Emergence 6 Months TotalEmployees Base Approval Date Post KERP
Pay of KERP Emergence Payment
Tier I 7 65% 5% 15% 40% 40% 100%Tier II 9 65% 5% 15% 40% 40% 100%Tier III 11 40% 5% 15% 40% 40% 100%Tier IV 53 20% 5% 15% 40% 40% 100%
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For the remaining proposed Retention Program participant, CEO Mark Burgess, the reten-tion incentive consists of the following scenarios:
(a) in the event of a reorganization in which Mr. Burgess is retained as CEO of thereorganized Debtor, Mr. Burgess would be entitled to i) a retention payment of$500,000, which is equal to 83 percent of his base salary, (payable upon the Debtor’semergence from Chapter 11), plus ii) additional payments of $500,000 if the enterprisevalue of the Debtor equals or exceeds $300 million together with an amount equal toone percent of the amount by which the enterprise value of the Debtor exceeds $300million (both of these additional payments would be payable 6 months after Debtoremerges from Chapter 11), or
(b) in the event of a reorganization in which Mr. Burgess is offered to be retained as CEOof the reorganized Debtor with an employment agreement that is at least equivalentto the prevailing terms of employment in the open market for CEO’s of similarlysized companies with usual and customary CEO duties, but Mr. Burgess declines toaccept the offer, then Mr. Burgess would be entitled to i) a retention payment of$500,000, which is equal to 83 percent of his base salary, (payable upon the Debtor’semergence from Chapter 11), plus ii) additional payments of $500,000 if the enterprisevalue of the Debtor equals or exceeds $300 million, together with an amount equal toone percent of the amount by which the enterprise value of the Debtor exceeds $300million and 12 months severance pay (these additional payments would be payableupon the earlier of the termination of Mr. Burgess’ employment with the Debtor or6 months after the Debtor emerges from Chapter 11); or
(c) in the event of a reorganization in which Mr. Burgess is not retained as CEO of theDebtor, or in a situation where Mr. Burgess is terminated without cause prior toemergence to Chapter 11, or in which the Debtor’s offer of continued employmentto Mr. Burgess is not at least equivalent to the prevailing terms of employment inthe open market for CEO’s of similarly sized companies with usual and customaryCEO duties as discussed in (b) above, Mr. Burgess would be entitled to i) a retentionpayment of $600,000, which is equal to his base salary (payable upon the Debtor’semergence from Chapter 11), plus ii) additional payments of an amount equal to onepercent of the amount by which the enterprise value of the Debtor exceeds $300 millionand 18 months of severance pay (both of these additional payments would be payableupon the earlier of the termination of Mr. Burgess’ employment with the Debtor or6 months after the Debtor emerges from Chapter 11, with the exception of the casewhere he is terminated without cause prior to emergence from Chapter 11, wherebythe payment based on the enterprise value calculation would be paid within 30 daysof the emergence date); or
(d) in the event of a sale of substantially all of the assets of the Debtor, Mr. Burgesswould be entitled to i) a retention payment of $500,000, which is equal to 83 percentof his base salary, plus ii) additional payments of $500,000, if the gross sales priceof the assets of the Debtor equals or exceeds $300 million, together with an amountequal to one percent of the amount by which the gross sales price of the assets of theDebtor exceeds $300 million and 12 months severance pay (these additional paymentswould be payable upon the earlier of the termination of Mr. Burgess’ employmentwith the Debtor or 3 months after the completion of the sale of substantially all ofthe assets of the Debtor).
RETENTION AND INCENTIVE BONUS TIED TO DEVELOPING RESTRUCTURINGPROCESS (FILING A PLAN), OPERATION COMMITMENT, SPEED, AND EMER-GENCE
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Excerpts from the “Motion for an Order Authorizing Debtors to Implement a Key Employee RestructuringMilestone Incentive and Income Protection Program” filed by Exide Technologies on April 15, 2002with the US Bankruptcy Court for the District of Delaware.
The Incentive Plan provides incentives to Key Employees to remain with the Debtorsthroughout the Reorganization and to implement the changes needed to successfully com-plete the Reorganization. Under the Incentive Plan, participants can earn an additionalbonus equal to 10-100% of their annual base pay. Each program participant received 25%of their Incentive Plan bonus after completing the Debtors’ Five Year Business Plan. EachParticipant will receive the second 25% of their Incentive Plan bonus if and only if theymeet certain operation and restructuring commitments that have been assigned to eachparticipant. The final 50% of their Incentive Plan bonus will be paid to eligible employeeson the day the plan of reorganization is approved. However, the plan of reorganization mustbe approved on or before June 30, 2003 to qualify for the third phase of the payment. Thus,because a portion of a participant’s payout is contingent upon continuing service throughmost- and hopefully all-of the Reorganization process, the participant will be motivated tostay with the Debtors and to assist in the Debtors’ efforts during these Chapter 11 Cases.
INCENTIVE BONUS TIED TO FILING A PLAN, EMERGENCE, TARGET CASHFLOW AND WORKING CAPITAL, AND ENTERPRISE VALUE
Excerpts from the “Debtors’ Motion for an Order Authorizing the Implementation of the Calpine IncentiveProgram” filed by Calpine Corporation on April 6, 2005 with the US Bankruptcy Court for theSouthern District of New York.
The Emergence Incentive Plan (EIP) provides cash awards - payable only at emergence- to selected senior employees in the positions most capable of influencing the success ofDebtors’ ongoing business and reorganization efforts. The purpose of the EIP is to providea compelling and market-competitive cash incentive designed to encourage key manage-ment personnel to maximize the value of the enterprise while working toward a successfulreorganization of Debtors’ business. The plan is specifically geared toward rewarding thoseemployees who will devote their energies, knowledge, and creativity to consummating asuccessful plan of reorganization.
There are three principal benefits of the EIP. First, the plan is simple in concept and admin-istration. The structure of the EIP mirrors that of the incentive opportunities jointly devel-oped by Calpine and the Committee for Debtors’ chief executive officer and chief financialofficer. Second, the structure of the EIP motivates eligible employees to increase Debtors’enterprise value-directly benefiting all stakeholders-by tying EIP award level to value cre-ation. Compensation for eligible employees increases proportionate to the value createdfor Debtors and their creditors. Thus, the financial interests of Calpine, creditors and coremanagement are aligned. Third, the EIP is designed to provide a market-competitive long-term compensation opportunity for eligible employees. Accordingly, compensation levels foreligible employees are in line with long-term equity and cash-based opportunities at com-parable institutions. The Debtors have identified approximately 20 senior employees, whichinclude primarily executive vice presidents and a select group of senior vice presidents, whowill be eligible to participate in the Emergence Incentive Plan.
The Debtors seek also to implement a Management Incentive Plan (MIP) for approximately600 of Debtors’ employees who occupy positions critical to the operation of Calpine’s ongo-ing business as well as Debtors’ specific reorganization goals. At its core, the MIP will besimilar to the traditional bonus programs (the “Bonus Programs”) utilized by the Debtorspre-petition. The Management Incentive Plan will consist of awards as described below
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to be paid for performance for the calendar year 2006 and beyond. The MIP is designedto achieve two goals. First, the plan creates value by motivating employees to work effec-tively and expeditiously to achieve critical short term operational and financial goals-bothof which advance the interests of creditors and the estate in a timely emergence from re-structuring. Thus, the MIP meets the goal of aligning the interests of Calpine, its creditors,and its employees so that success is shared by all. Second, the plan provides market-competitive compensation opportunities for participants that are consistent with Calpine’shistorical practices while tempered by the financial constraints under which Calpine op-erates. Market-competitive compensation helps achieve the goal of preserving a criticalasset of the Debtors-their human capital-by promoting employee loyalty and morale andmilitating against attrition.
The first performance period will run from January 1, 2006 to June 30, 2006. Duringthis period, performance will be measured relative to four goals: (a) delivery of a BusinessPlan to the Board of Directors by June 1, 2006; (b) achievement of a target-adjusted cashflow that is calculated as an improvement to the DIP budget; (c) achievement of specificheadcount reductions and cost-cutting goals; and (d) the achievement of a working capitaltarget. The second performance period would run from July 1, 2006 to December 31, 2006.The performance measures for this period will be set forth in the Business Plan requiredto be delivered to the Board of Directors prior to the end of the first performance period.Payments under the MIP will only be made if performance objectives are achieved.
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