BANKRUPTCY AS A
CORPORATE
RISK-MANAGEMENT
STRATEGY
Cynthia L. Krom, PhD, CPA, CFE
“…the reason why firms
succeed or fail is perhaps the
central question in strategy.”
~ Porter (1991, p.5)
What is Chapter 11 bankruptcy?
Bankruptcy Reform Act of 1978
“Reorganization”
Assets are frozen
 Temporary relief from collection
attempts, foreclosure, and creditor
lawsuits
Protect the rights of creditors
On average, a 2 - 3 year process

Incidence of bankruptcy filings
57312
Per year
31510
Per year
1975 - 79
Source: American Bankruptcy Institute
1980 - 85
“Risk-management” Bankruptcy



“Strategic” bankruptcy – Delaney (1989, 1992)
“Non-financial” bankruptcy – Bankruptcy Yearbook
and Almanac (annual since 1980s)
“Creative” bankruptcy – W. Brown (1988)
Not
Financially-distressed
Financially
Distressed
Non-bankrupt
I
II
Bankrupt
III
IV
Source: Foster 1986
Risk-management reasons for filing for
bankruptcy protection
Asbestos liabilities
 Labor relations issues
 Regulatory/nuclear/environmental problems
 Other litigation & contract problems
 Patent lawsuits
 Pension disputes
 Personal injury lawsuits

Source: Bankruptcy Yearbook and Almanac
FIRST LINE OF QUESTIONING
ARE THERE FINANCIAL DIFFERENCES
BETWEEN RISK-MANAGEMENT
BANKRUPTCIES AND FINANCIAL DISTRESS
BANKRUPTCIES?
ARE THEY DRAWN FROM THE SAME
POPULATION?
Financial “health” compared for third
and second years prior to Chapter 11
ALTMAN’S Z-SCORE
FDB < RMB
For the third and second year prior to the year
in which bankruptcy filings were made, firms
considered to have filed for Chapter 11
protection due to financial distress (FDB) will
have Altman’s Z-scores lower than those for
firms filing for Chapter 11 protection for risk
management reasons (RMB).
Methods to test for financial differences
FDB < RMB
Altman’s Zscore
1998 – 2007
Large publicly-traded firms filing for and
emerging from Chapter 11
Data from form 10-K from SEC
Altman’s Z
categorical
n = 27 RMB
n = 199 FDB
n = 27 RMB
matched
n = 27 FDB
Mean Altman’s Z-scores (n=452)
7
6
5
Mean Altman’s Z-score 3
years prior to bankruptcy
4
3
Mean Altman’s Z-score 2
years prior to bankruptcy
2
1
0
FDB
RMB
Non-bankrupt
RESULTS: ALTMAN’S Z-SCORE (n=227)
THIRD YEAR PRIOR TO CHAP 11
N
Mean
Rank
SECOND YEAR PRIOR
Sum of Ranks
N
Mean
Rank
Sum of Ranks
FDB
200
107.05
21410.00
FDB
199
107.98
21489.00
RMB
27
165.48
4468.00
RMB
27
154.15
4162.00
Third year prior to BR
Second year prior
Mann-Whitney U
1310.000
1589.000
Wilcoxon W
21410.000
21489.000
-4.340
-3.442
.000
.001
Z
Asymp. Sig. 2-tailed
RESULTS: ALTMAN’S Z-SCORE
CATEGORICAL FDB v. RMB (n = 54)
THIRD YEAR PRIOR TO CHAP 11
SECOND YEAR PRIOR
Asymp
. Sig.
(2sided)
Value
df
Pearson
Chi-Square
15.219
2
.000
Likelihood
Ratio
19.598
2
Linear-byLinear
13.581
1
Asymp
. Sig.
(2sided)
Value
df
Pearson
Chi-Square
11.314
2
.003
.000
Likelihood
Ratio
14.839
2
.001
.000
Linear-byLinear
6.111
1
.013
FIRST LINE OF QUESTIONING:
FAILED TO SUPPORT THAT
FINANCIAL-DISTRESS BANKRUPTCIES AND
RISK-MANAGEMENT BANKRUPTCIES
ARE DRAWN FROM THE SAME POPULATION
WHAT ABOUT RMB COMPARED TO NON-BANKRUPT?
MIXED RESULTS
SECOND LINE OF QUESTIONING
DO FINANCIAL-DISTRESS BANKRUPTCIES
AND RISK-MANAGEMENT BANKRUPTCIES
DIFFER IN TURNOVER OF THE TOP
MANAGEMENT TEAM AND THE BOARD
OF DIRECTORS?
Hypothesized
FDB turnover > RMB turnover
27 RMB
27 FDB
matched
27 Non-BR
matched
Chief Executive Officer
 Chief Financial Officer
 Chief Operating Officer
 Chairperson of the Board
 Members of the board
Data from 10-K and DEF 14A forms

2 years prior through BR year
3 years post BR year
2 years prior through 3 years post BR year
SECOND LINE OF QUESTIONING

During the 6-year time period FDB FIRMS HAVE MORE
TURNOVER THAN RMB FIRMS FOR:
CEO (p < .05)
 CFO (p < .01)
 COO (p < .01)
 Members of the Board (p < .000)


During the 6-year time period RMB FIRMS HAVE MORE
TURNOVER THAN NON-BANKRUPT FIRMS FOR:
CEO (p < .05)
 CHAIRPERSON OF THE BOARD (p < .05)

• First
study to support, with financial data, the
differentiation of Chapter 11 bankruptcy into FDB and
RMB
• First study to examine the implications for turnover in
the top management team related to FDB and RMB
• First
study to examine the implications for turnover in
the board of directors related to FDB and RMB
• One of the first studies in years to look at executive or
board turnover as related to bankruptcy in any form
CONTRIBUTIONS OF THIS STUDY
ALSO: Suggests that bankruptcy modeling may be improved if RMB
incidents are segregated from other bankruptcies.
• Small
sample size limited the power of the statistical
tests.
Over time, as more Chapter 11 bankruptcies occur, more data
will be available
• Use of archival data permits only a coarse-grained
approach (annual, not daily)
• Inability
to access the “insider” information that would
illuminate reasons for executive departure, rationale for
filing Chapter 11, etc.
LIMITATIONS OF THIS STUDY
• Could
extend beyond the U.S. to other countries with an
option similar to Chapter 11
• Could explore relationship between RMB and board
composition, board power, insider ownership, etc.
• Could explore other signals of RMB, including
discretionary accruals, lease ratios, analysts’ ratings
• Consider implications of RMB to ratings of corporate
social responsibility
SUGGESTIONS FOR FUTURE RESEARCH