Key Success Factors in the Revitalization of Distressed Firms:
A Case of the Korean Corporate Workouts
Dongsoo Kang
Korea Development Institute
February, 2004
Abstract
This paper explores the empirical performances of the workout companies
with special interests in the effectiveness of corporate reorganizing tools on
their revitalization. In the empirical analysis it considers the criteria of
success or failure in restructuring from both creditors’ and debtors’
perspectives in a separate manner. The key results are summarized as
follows. First, the initial conditions on the debt structure of the workout
companies are significantly related to the revitalization from both creditors’
and debtors’ point of view. Second, the debt restructuring instruments are
insignificant in the success of corporate turnarounds, but the debt-to-equity
conversion has been a relatively effective tool. Third, the selfrestructuring efforts, employment downsizing and governance reshuffling
do not affect the performances significantly.
Key Words: Corporate Distress, Corporate Workouts, Reorganization
JEL Classification: G34, G38, C35
1. Introduction
The massive corporate sector distresses around the 1997 financial crisis in Korea,
combined with the danger of financial markets collapse due to subsequent capital
inadequacy of most commercial banks, called attention to the wide uses of corporate
finance tools under bankruptcy. In that the financial crisis is an event that periled not only
the viability of the individual firms but also that of the entire financial system, most
corporate distresses cannot ravel out solely with formal resolution methods, or bankruptcy
filings to the court. In addition to the weak capacity and deficient expertise of the court, a
host of distressed companies and sizable amounts of the delinquent debts that could further
exacerbate the already crisis-hit economy render the formal bankruptcy procedures
insufficient as well as inefficient. Indeed, according to Worldbank (1999), more than 80
percent of the corporate restructuring is known to follow the private agreements among the
relevant stakeholders rather than the court decisions under crisis situations.
The Korean Corporate Workouts Program was born in 1998 at the height of the systemic
crisis, aiming at rescuing both distressed companies and financial institutions when the
delinquency of the former was necessarily a threat to the fate of the latter as well. Most
financial institutions, including major commercial banks troubled with capital inadequacy,
could not afford to take fair but costly bankruptcy procedures against their non-performing
corporations. They needed the time and resources with which to reorganize themselves
along with rehabilitating the debtor companies. From the government perspective it would
be too costly to apply to all the distressed companies the market principles and in-court
restructuring methods which could lead liquidations in many cases. The managers and
owners of the distressed companies preferred to be under the Corporate Workouts, for they
might have had more chances to lose the management rights under the court decisions. The
workers in these companies also could expect to retain their jobs, otherwise they would
have been dismissed in the course of harsh employment restructuring. For these incentives
the government initiated the proposal of the Corporate Workouts and all the other related
stakeholders reached an agreement.
This research explores the empirical performances of the workout companies with
special interests in the effectiveness of corporate reorganizing tools on their revitalization.
More specifically, a logit model is used to evaluate the significance of the variables, in
addition to initial conditions of the workout companies, corresponding to the categories of
the reorganizing tools like debt restructuring, employment downsizing, business or asset
sales, and governance reshuffling. Thus, it may be called a revitalization prediction model
for distressed companies, vis-à-vis the bankruptcy prediction models in the corporate
finance literature.
The empirical analysis reflects on the criteria of success or failure in restructuring from
the creditors’ and debtors’ perspectives separately. The creditors are ultimately interested in
the debt service capacity of the workout companies. In contrast, business rehabilitation in
the operational aspect becomes a primal norm of success from the debtors’ perspective.
Then the evaluations on the Corporate Workouts against the same performance may be
interpreted in a different manner depending on the choice of the criteria.
This study reports the importance of the initial condition factors like debt structure of the
workout companies, regardless of the choice of the criteria; the simpler the creditor
structure, the better the performances of corporate restructuring. While the debt
restructuring instruments are insignificant in the results of the Corporate Workouts, the
debt-to-equity conversion seems to be relatively effective. The self-restructuring efforts,
employment restructuring and management and ownership reshuffling do not turn out to be
critical in the corporate turnarounds on both criteria. It is found that the restructuring results
of the non-Daewoo and manufacturing firms, among the subsamples, are well accounted for
1
by the explanatory variables.
This study also observes that, in view of the financial statements, the Korean Corporate
Workouts Program has contributed to improving the debt service capacity and business
activities of the normalized workout companies. For a few years after the commencement
of the program the performances looked stagnant due to the capital inadequacy of the
financial institutions and the resulting difficulties in reaching a consensus on the workouts
plans, but the execution of the plans has started to produce distinct accomplishments from
2001. As of the end of 2002 the average business operations of the graduated and selfrestructuring workout companies are close to those of the corporate average, though they
still have heavier burdens on interest payments.
This paper is organized as follows. Section 2 overviews the Korean Corporate Workouts
Program. After discussing the background for and characteristics of the program, we look
around the descriptive statistics about the workout companies and restructuring
achievements. Section 3 introduces the empirical methodologies and defines the variables
of interest. Then the results about the factors affecting the performances of the Corporate
Workouts are provided and explained. In Section 4 the overall performances of the
Corporate Workouts are discussed with the data in the financial statements. Section 5
contains the concluding remarks.
2. Overview of the Korean Corporate Workouts Program
2-1. Background
From the beginning of 1997, just before the outbreak of the financial crisis, a few large
corporations went into bankruptcy and many sizable business groups became financially
distressed due to illiquidity, which ignited massive loan collections by creditor financial
institutions, especially merchant banks. As the urgency about systemic crisis grew up over
the entire economy, creditor banks assumed the leadership to rescue the distressed
companies under the so-called Insolvency Respite Agreement on April 18, 1997. Though
the agreement contributed to the postponement of market failures resulting from the
bankruptcy of troubled firms all of sudden, the effect was only temporary. Until the end of
1997, the agreement was applied to 33 companies, of which 6 and 25 ones filed for the
court-led Corporate Reorganization and Composition, respectively. On top of the existence
of non-participating creditor financial institutions in the agreement such as investment trust
companies, insurance companies, brokerage houses, merchant banks, etc., the lack of
mediators to bridge the gap of different opinions among the creditors limited the successful
performances of the agreement. The management and/or owners of the debtor companies
with the worries about losing management rights were also passive in receiving financial
assistance under the agreement. Thus, this kind of regime turned out to be ineffective
toward a best practice of corporate restructuring in the crisis situations where every
economic agent does not have a room for considering others’ distress due to concerns over
its own viability.
Massive corporate distresses near insolvency around the financial crisis periled not only
sound firms in the corporate sector but also almost all financial institutions. On top of the
already deepened credit crunch in financial markets, the in-court restructuring against all
the problematic companies might have had a danger to paralyze the flow of funds and
corporate businesses, which could have further exacerbated the overall catastrophic
situations, ending up with a vicious spiral. Above all, the financial health of most financial
institutions could not afford to take costs to absorb losses from the court-led restructuring.
Under these circumstances, the Korean Corporate Workouts Program was initiated by the
2
Financial Institutions Agreement for Promotion of Corporate Restructuring (hereafter the
Agreement) signed by the 210 creditor financial institutions on June 25, 1998, as a
successor to the former Bankruptcy Respite Agreement.
2-2. Characteristics of the Korean Corporate Workouts
Workouts refer to a negotiated agreement between the debtors and their creditors outside
the bankruptcy process. In workouts, the debtor has to convince the creditors that they
would be financially better off with the new terms of a workout agreement than the terms of
a formal bankruptcy. The main benefits of workouts are cost savings and flexibility. These
benefits, however, do not come without risks. The key risk is a holdout problem associated
with the stakeholders’ violation away from the agreement. If this problem cannot be
circumvented or controlled, workouts are inferior to the formal bankruptcy filing.
The Korean Corporate Workouts Program has the common flavors of ordinary workouts,
but is not exactly the same in terms of its objectives and operations. It was initially prepared
for restructuring financially unhealthy medium sized chaebol companies, especially
targeting for 6-64 largest conglomerates in asset size. It can be defined as not only a
corporate sector restructuring program aiming at resolving corporate distress, but also a
subsidiary one to support financial sector restructuring. As a matter of fact, the latter
objective was in forefront, for a priority of policy considerations should be given to
rescuing hard-hit financial system by the crisis.
The Workouts Program in Korea is understood as being semi-formal, instead of being
informal, in terms of policy-making structure. Officially, it is the creditors’ committee
(Council of Creditor Financial Institutions) that determined to convert original debt
covenants to new ones. Practically, the Corporate Restructuring Coordination Committee
(CRCC), a mediator that creditors established in order to resolve technical problems in the
process of negotiations, played critical roles in preparing for every detail in the new
contracts. Though consisting of private members, CRCC had close ties with the Financial
Supervisory Commission (FSC) that was a control tower orchestrating both financial and
corporate sector restructuring. CRCC and FSC collaborated with each other in the
architecture of debt reduction such as the amounts of write-offs, maturity extensions, debtequity swap, etc., because its size would be in tandem with the amounts of recapitalization
of the creditor banks assisted by the public funds. Government involvement in the corporate
workout processes was inevitable in view of the depth of the corporate and financial sector
distress. Under the circumstances where banks were subject to considerable risks of closure,
their optimal behavior should be passive in corporate restructuring that could yield their
insolvency or illiquidity. After the Council of Creditor Financial Institutions approved the
restructuring plans, it is then the main bank that took the ensuing actions like execution,
implementation, monitoring, and even additional loan arrangements. In summary, the
Korean Corporate Workouts Program contains the mixed flavors of the government-led
restructuring in essence, market-led one in its form and bank-led one in real operations.
2-3. The Workout Companies
After the main creditor bank of the Kohap Group took the four subsidiaries to the
Corporate Workouts Program on July 6, 1998, the 104 companies had been under the
scrutiny of the affiliated creditor financial institutions with the Agreement. The workouts
against the 8 companies out of the entire applicants were repealed either by the creditors
having suspicions over their viability or by the owners of the companies having worries
over losing the management rights. Thus, the creditor financial institutions commenced the
Corporate Workouts with 96 ailing firms. In the course of the Workouts, 17 companies were
3
merged into their respective mother companies and 4 companies were partitioned from the
Daewoo Corp. and the Daewoo Heavy Industry, Ltd. The total number of the workout
companies is then 83.1 Table 2-1 summarizes the workout companies.
Table 2-1. Summary of the Workout Companies
Application
104
Workout Companies
Rejection
8
Approved
Merger (∆)
Partition
Total
96
17
4
83
Out of the 83 workout firms, 55 ones entered into the Workouts Program in 1998. These
are the companies belonging to medium sized chaebols or independent ones. After the
second largest chaebol in Korea, the Daewoo Group, declared moratorium against the debts
from the financial institutions in July1999, 12 Daewoo subsidiaries and related companies
were put under the program (See Table 2-2). In terms of the number of the companies,
Daewoo subsidiaries took one fifth, but nearly two thirds of the notified debts was the
Daewoo’s. Out of the total KRW 103.8 trillion, the Daewoo’s liabilities to the financial
institutions reached KRW 66.6 trillion (See Table 2-3).
The results of the Corporate Workouts as of the end of 2002 are reported in Table 2-4.
Out of the entire sample, 40 companies had already graduated from the Workouts Program
and 15 companies are conducting self-restructuring away from the Council of Creditor
Financial Institutions. From the creditors’ point of view, the 55 companies that are
categorized into these two groups, or called normalization, seem to become revitalized with
high probability. However, the Workouts Program was suspended against the 16 companies
and in progress for the 12 companies.
Table 2-2. Companies Entering into the Corporate Workouts Program
1998
1999
2000
Total
Ratio (%)
-
12
41)
16
19.3
Non-Daewoo
55
10
2
67
80.7
6-64 group
26
3
2
31
37.3
Others
29
7
-
36
43.4
Total
55
22
6
83
100.0
Daewoo
Note : 1) Partitioned companies from Daewoo Corp. and Daewoo Heavy industry, Ltd.
Source : Financial supervisory Service (2003).
1
This paper sets the number of the entire sample of the workout companies to be 83 hereafter.
4
Table 2--3. Notified Debts of the workout companies
(unit: KRW billion, %)
1998
1999
2000
Total
Ratio
Daewoo
-
66,577
-
66,577
64.1
Non-Daewoo
33,382
1,584
2,254
37,219
35.9
Total
(ratio)
33,382
(32.2)
68,161
(65.6)
2,254
(2.2)
103,796
(100.0)
100.0
Source: Corporate Restructuring Coordinating Committee.
Table 2-4. Results of the Workout Companies as of the end of 2002
Chaebol
Others
Total
Total
Graduation
47
(100.0)
36
(100.0)
83
(100.0)
20
(42.6)
20
(55.6)
40
(48.2)
Normalization
Self-res
Sub-total
tructuring
8
(17.0)
7
(19.4)
15
(18.1)
28
(59.6)
27
(75.0)
55
(66.3)
suspension
Distress
InProgress
9
(19.1)
7
(19.4)
16
(19.3)
10
(21.3)
2
(5.6)
12
(14.5)
Sub-total
19
(40.4)
9
(25)
28
(33.8)
Note : ( ) is ratio in percentage
2.4. Initial Financial and Business Conditions of the Workout Companies
There exist a number of factors that could affect the performances of the Corporate
Workouts. Much literature has reported the initial conditions of the workout companies as
one of the most important factors.
Table 2-5 depicts the initial debt structure and business conditions of the non-financial
73 workout companies, of which the data are available. The banks’ credits ratio to the total
notified credits is around 30%, which does not vary much over industry, workout results,
and Daewoo or not. The top five creditors’ credit ratio is about 70%, while the average total
number of creditors being 24.5. Namely, the debts are fairly concentrated on the small
number of creditors. The number of the Daewoo’s creditors is also similar to that of others,
but we should be careful about reading the numbers of the Daewoo because the numbers
were collected after the commencement of the Corporate Workouts. Before the Daewoo
subsidiaries were put under the Program, there existed 480 creditors from 69 countries
against them. Aiming at pursuing efficient corporate restructuring, the government got
involved in the debt negotiation with foreign creditors. As a result, the Korea Asset
Management Corporation (KAMCO) purchased the foreign Daewoo debts of the nominal
amounts 36.9 billion US dollars at 43 cent per a dollar on average.2
2 See Jeong and Hong (2003) for the detailed story of the KAMCO’s acquisition of the foreign debts of the
Daewoo subsidiaries.
5
Table 2-5 does not capture this simplification process. This table also reports the average
ratio of going concern business value to liquidation value in the last column.
Table 2-5. Initial Debt Structure and Business Conditions of the Non-financial
Workout Companies
Section
Manufacturing
[53]
Construction
[10]
Retail &
Industry
Wholesales
[7]
Others
[3]
Graduation
[36]
SelfRestructuring
Workout
[12]
Result
In-Progress
[12]
Suspension
[13]
Daewoo
[10]
Daewoo
Non-Daewoo
[63]
All
[73]
Note:
Relative to Total Credits of Financial Institutions(%)
Top Five
Banks'
No. of
No. of
Creditors' Guarantees
Credits
Creditors Banks
Credits
31.2
71.3
34.0
24.4
8.8
(14.3)
(16.4)
(20.4)
(16.6)
(5.1)
25.4
63.6
26.3
28.0
12.3
(10.7)
(16.3)
(14.0)
(13.7)
(5.8)
GCBV1)
LV
1.5
(0.5)
1.6
(0.4)
29.9
(17.1)
67.0
(15.1)
23.4
(17.4)
25.9
(23.2)
9.7
(5.0)
1.5
(0.4)
51.2
(17.5)
31.5
(13.9)
92.0
(13.0)
74.4
(15.9)
39.8
(22.0)
34.3
(22.2)
9.7
(7.2)
18.1
(10.7)
4.3
(3.5)
7.8
(3.9)
1.8
(0.1)
1.6
(0.4)
41.6
(19.7)
75.1
(15.8)
32.9
(11.7)
21.4
(13.7)
7.8
(4.7)
1.3
(0.8)
25.0
(10.3)
27.0
(12.1)
23.2
(10.3)
32.3
(15.0)
30.9
(14.7)
59.5
(10.7)
67.4
(19.9)
61.2
(18.3)
72.2
(16.1)
70.7
(16.6)
24.3
(11.0)
32.9
(22.3)
13.7
(8.8)
35.1
(19.1)
31.7
(19.7)
38.3
(13.9)
31.2
(24.1)
39.4
(23.7)
22.1
(14.2)
24.5
(16.6)
12.2
(5.9)
11.4
(6.9)
11.7
(5.8)
8.8
(5.1)
9.2
(5.2)
1.5
(0.4)
1.3
(0.4)
1.5
(0.5)
1.5
(0.5)
1.5
(0.5)
[ ]: number of observations
( ): standard deviation
1) GCBV: Going Concern Business Value
LV
: Liquidation Value
2-5. Specific Restructuring Methods in Detail
Corporate restructuring aims at reorganizing the financial and business structures of the
ailing or failing companies through various methods. By and large, we can categorize the
reorganizing efforts into groups from the following four aspects: debt, business,
employment, and governance. In this subsection, we overview the specific corporate
restructuring methods used in the Workouts
6
(1) Debt Restructuring
Debt restructuring is a prime ingredient of the Corporate Workouts because the direct
causes of corporate distress stem mostly from high external debts relative to debt service
capacity. Interest relief and composition are typical methods of debt restructuring. Interest
relief includes debt extension of payment terms and/or conditions, lower interest rates on
debts, etc. Composition means a haircut of principal of the debts. When the creditors
exempt the debtors from paying the principal, the former usually reduces the equities of the
latter and convert the debts into either equities or convertible bonds (CBs) in order to
recoup the upside potential of recovery.3
When the creditors reset the interest rates, they calculated the sustainable debt amounts
based on the estimates of future free cash flows. The excessive amounts over the affordable
debts were converted into equities or CBs and then lower interest rates were applied to the
remaining debts. Table 2-6 summarizes the contents of debt restructuring in the Workouts
Program. The major instrument is the interest rate reduction. As for the debt amounts KRW
66.1 trillion, or 67% out of total debt restructuring KRW 98.7 trillion, interest rates were
lowered or periods of interest payments were extended. Debt-to-equity and debt-to-CB
conversion for the unsecured claims4 were widely used in the Corporate Workouts, too:
KRW 15 trillion and KRW 3.3 trillion, respectively.
Table 2-7 shows the interest rates on the workout companies over time. From 1998 to
2002, the corporate loan rates had declined monotonically due to economic recovery from
the crisis and stabilized inflation. Following this trend, coupled with an improved ability of
the financial institutions to absorb losses from the non-performing loans, the interest rates
applied to the workout companies had also declined until 2001. In 2002, however, despite
the low loan rate on corporations, the interest rates for the workout companies rose because
the massive debt-to equity conversions, especially for the Daewoo subsidiaries, reduced the
credits applied to low interest rates.
Table 2-6. Debt Restructuring for the Workout Companies
(unit: KRW billion)
Debt relief
Debt-equity conversion
Others1)
Total
10,996
4,552
25,173
1,297
6,478
1,705
23,443
247
573
819
1,390
49,282
14,966
3,328
18,293
7,647
97,898
Interest
rate
reduction
Normal
interest rate
Subtotal
Equity
conversion
CB
conversion
Subtotal
Normalization
6,570
3,056
9,625
9,537
1,458
In
Progress
13,498
1,762
15,260
5,18,
Suspension
46,070
1,002
47,072
Total
66,137
5,821
71,958
Note : 1) netting deposits and loans, discounted debt redaction, exemption of guaranteed debts.
3 In order to facilitate equity conversions, the government revised regulations on the financial institutions.
In the case of an equity investment on the workout companies, the ceilings on securities investment of financial
institutions, or less than 15% of the voting stock in any other company, are not applied.
4 The secured creditors tried to avoid equity conversion, worrying about the losses from security
evaluations. However, there are cases in which secured creditors participated in the recapitalization. In such
cases the stock price exceeded the face value in the exchanges or put-back option was provided.
7
Table 2-7. Interest Rates on the Workout Companies
(unit: %. %p)
Secured Credits (A)
1998
1999
2000
2001
2002
Average
9.8
8.3
8.2
5.4
6.9
7.7
6.6
5.0
6.5
6.6
1)
Unsecured Credits (B)
9.9
5.2
Difference (A-B)
- 0.1
3.1
1.6
0.4
0.4
1.1
Average for workout
companies
9.9
5.8
7.2
5.1
6.6
6.9
Corporate loan rate
15.2
8.9
8.2
7.5
6.5
9.3
(2) Business Reorganization
In return for the debt restructuring, the creditors usually ask the debtors to reorganize the
business toward raising long-term profitability. Also, the companies that were not able to
survive only with debt restructuring should employ business restructuring. Some of the
examples are sales of assets like real estates, securities, businesses, etc., and recapitalization
like external equity participation.
In order to support these self-restructuring efforts, the government revised the various
legal straightjackets. For example, corporate partition was introduced by the revision of the
Commercial Act, to allow comprehensive transfer of businesses. This helped to reduce the
costs of business sales and subsequently those of corporate restructuring.5 In order to
facilitate M&A, the investors on the workout companies are exempted from tender offer
clauses in the Securities and Exchange Act.6 To invite foreign investments on the distressed
companies, exemption of foreign investors from the restrictions on gross amount of
investment became removed. Through a number of revisions of the Special Tax Treatment
Control Act, tax incentives for corporate restructuring have been provided as well.
Table 2-8 reports the data on the self-restructuring efforts by the workout companies to
regain confidence in business operations. The self-restructuring efforts have been
concentrated on the Daewoo. More than 70% of the business restructuring in terms of the
amounts is attributable to the Daewoo subsidiaries. As a matter of fact, various approaches
have been experimented against them.7
Table 2-8. Business Restructuring Efforts by the Workout Companies
(unit : KRW billion)
5 The Daewoo Corp. and the Daewoo Heavy Industry adopted spin-off strategies for prospective businesses
according to the legal grounds for corporate partition.
6 According to the paragraph (1) of the Article 21 in the Securities and Exchange Act, a person who intends
to acquire voting stocks through a purchase outside the securities market or the association brokerage market
shall acquire the stocks through a tender offer in a case where the total number of the stocks held by such person
and specially connected persons after the purchase is 5/100 or more of the total number of the stocks.
7 As for the cases of restructuring the Daewoo subsidiaries, see Korea Development Bank (2003).
8
Asset Sales
Real
Estate
Security Business
Other
Assets
Owner
Sub- CapitaliContri
Subtotal sidiary zation -bution
Others
Total
Daewoo
2,014
496
2,319
386
5,145
465
990
121
287
7,008
NonDaewoo
782
725
639
266
2,411
221
20
0
317
2,969
2,795
1,221
2,958
652
7,557
685
1,010
121
604
9,977
Total
(3) Employment Restructuring
The employment restructuring is one of the components of the self-restructuring, but
needs to be discussed separately for its sensitivity. In the Corporate Workouts under the
crisis, unlike the private workouts under the normal times, policy makers should pay
attentions to unemployment on top of efficient system, for collective endeavors rather than
sacrifices of certain groups could be driving forces to overcome the catastrophic situation.
From the micro perspective, harsh employment downsizing may fail to obtain cooperation
from the laborers, one of the important stakeholders for the success of corporate
restructuring.
Table 2-9 shows the percentage changes in the number of employees and personnel
expenses of the workout companies. Overall, 32.6% of employees have been reduced
between the beginning and the end of the Workouts. This means over 31,000 laborers have
been laid off. The employment restructuring is more severe in the Daewoo subsidiaries in
terms of both the decreased rates of employees and personnel expenses. It is also interesting
to note that the per capita personnel expenses have increased since the laborers have
decreased more rapidly than the total personnel expenses. The workers who are able to keep
positions in the workout companies seem to be better off.
Table 2-9. Employment Restructuring in the Workout Companies
(unit : %)
Percentage Changes in
No. of Employees
Amount of Personnel
Expenses
Per Capita Personnel
Expenses
Daewoo
-39.29%
-21.10%
29.96%
Non-Daewoo
-26.51%
-1.38%
34.20%
Average
-32.55%
-11.21%
31.65%
(4) Governance Restructuring
Weak corporate governance has long been blamed for as one of the causes of the
financial crisis in Korea. The governance restructuring in the distressed companies like the
workout firms is of particular importance in that it could not only ask for the responsibilities
of the incumbent managers and owners for the ill management but also provide a
9
momentum for revitalization. That is, the governance improvement is consistent to fairness
and efficiency.
3. Factors Affecting the Performances on the Corporate Workouts
The five-year experiences of the Korean Corporate Workouts Program have produced
various experiments on the private, or semi-private at least, corporate restructuring led by
the creditors. They are quite unique in the sense that the data on the corporate rehabilitation
tools as well as the discrete results of either success or failure are available to the extent in
which empirical analyses could be feasible. In general, the corporate restructuring is
engaged in a series of confidential negotiations and terms of contracts so that only a
piecemeal set of information is available to the extent of case studies. The restructuring
efforts by both the creditors and debtors, however, have been traced and recorded by the
government authorities in Korea. The characteristics of the Korean Corporate Workouts
Program and its funding structure made the data collecting possible, though not publicly
available.
Based on the data on the entire workout companies, this section analyzes the factors that
have affected their performances. The logit regressions are used to construct a revitalization
prediction model vis-à-vis the bankruptcy prediction models in the corporate finance
literature. Basically both models are methodologically alike, but only the direction of
financial and business conditions of the firms under analysis is contrary. Whereas the
bankruptcy prediction models start with normal firms and classify them into either normal
or distressed ones in a certain period, the revitalization prediction model treats with
distressed firms initially and dichotomizes them into either revitalized or still distressed
ones after the restructuring processes.
3-1. Logit Model for the Prediction of Corporate Revitalization
The logit regressions are one of the most widely used methods for analyzing discrete
decision models when the dependent variable has binary responses. Unlike the
discriminant analysis proposed by Altman (1968), the logit model is less restricted in that
the explanatory variables used in the regressions do not necessarily follow the normal
distribution. Only the binding assumption is that the probability of residuals is a random
draw from a logistic distribution.8
The logistic distribution is similar to the normal one except in the tails, which are
considerably heavier. That is, the probability density of the logistic function is relatively
flatter than that of the normal distribution. It, indeed, more closely resembles a student tdistribution with seven degrees of freedom. Therefore, the logistic distributions tend to give
larger probabilities to both ends of the predicted event or non-event. Loosely speaking, the
logistic distribution is preferable to the probit one in the case where the explanatory
variables take wide divergent values. Since the explanatory variables are the initial status of
the workout companies about the debt structure and business prospects, or proxies for
various restructuring tools, they tend to have different values depending on the types of
distress and restructuring prescriptions. In this sense the logit model is a statistically good
candidate for the prediction of corporate revitalization of the workout companies.
3-2. Criteria for Successful Restructuring
8 The difference of the probit model from the logit is that the probability of residuals is a random draw from
a normal distribution.
10
The workout companies belong to, after the rehabilitation processes, one of the two
groups, either revitalized or distressed. If a workout company becomes revitalized, we call
the event occurred. Otherwise, the event does not occur. Denote the event to be 1 and nonevent to be 0.
What should be criteria on which the workout companies are determined as revitalized
or distressed? The criteria can be rather arbitrary and subjective. Depending upon the status
of the decision makers, a once distressed firm is believed to be already revived or far from
the normal state. For example, suppose that a financially troubled company starts to make
interest payments on time after debt rescheduling and self-restructuring efforts like real
estate sales, but its business operations are not competitive enough relative to the cohorts in
the same industry. In order to regain competitiveness, it should downsize employment and
focus on the core business areas. In such a case, the company might be performing again
from the creditors’ perspective but highly likely to fall into trouble in a near future without
further restructuring. That is to say, it may not be performing yet from its own perspective.
This paper looks into the performances of the Corporate Workouts from the standpoint
of both the creditors and debtors. One of the feasible creditors’ views is the decisions made
by the Council of Creditor Financial Institutions. The Creditor Council categorizes the
workout companies into four groups. First, the workout companies that are capable of
raising funds with their own credits in the markets, the Council graduates them from the
Program. Second, the companies, of which the debt size is manageable and business
conditions are prospective despite potential risks of debt redemption pressure, proceed to
self-restructuring. The first and second cases combined are called as normalization. The
third group is suspension. The companies belonging to this category does not have a
foreseeable future to get revived in the core business areas or meet the financial obligations
by all means. The last group is in-progress. Even after three to five years in the Corporate
Workouts Program some companies are still under the collective management by the
creditor financial institutions. In this paper, from the creditors’ perspective, the normalized
companies are defined as revitalized, while the suspended and still in-progress companies
are defined as distressed.
The view of the debtor, or the workout company, on the success or failure of the
Corporate Workout Program seems to be different. Since the goal of the distressed company
is to resume making reasonable level of profits, business operations must be on right track.
Even if the debt service capacity is regained, the company should make further efforts to
survive so long as the financial health originates only from the massive debt restructuring.
Thus, the criteria on the revitalization or distress of the workout companies from their own
perspective are the ones related to business operations that persistently strengthen their
viability. One of the candidates is operating profits, instead of net profits, for which may
contain huge special profits due to debt reductions. A once financially distressed firm is
called to get revitalized at least when the operating profits should be greater than its interest
expenses.
Table 3-1 summarizes the above discussion. The Criterion 1 is the one from the
creditors’ perspective. Revitalization is identified with the normalization discussed above.
The normalization, namely the graduation and self-restructuring, does not necessarily mean
the successful restructuring in the conventional context. Rather, it must be narrowly
understood as the state where the creditors could maximize the recovery of the delinquent
debts. Criterion 2 is the one from the debtors’ perspective. The basic concept for
revitalization is the regained capability of viable business operations, which is an empirical
issue. We can set out various measures for the Criterion 2. This paper chooses operating
profits to interest expenses ratio as the best fitting variable. The cut-off value is used as the
average of the ratios of the entire companies under the external auditing from 1995 to 2002.
11
Table 3-1. Definition of Revitalization and Distress
Perspective
Revitalization
Distress
Criterion 1
Criterion 2
Creditors
Debtors
Normalization (e.g.)
Viable business operations
graduation and
(e.g.) Operating profits
Self-restructuring
Interest expenses ≥ Corporate average
Suspension or InProgress
Non-Viable business operations
Operating
profits
(e.g.)
< Corporate average
Interest expenses
3-3. Explanatory Variables
The explanatory variables are selected from the following five groups: 1) initial status,
2) debt restructuring, 3) business restructuring, 4) employment restructuring, and 5)
governance reshuffling. First, the initial status of the workout companies includes the debt
structure and business conditions when they applied for the Corporate Workouts Program.
For example, the variables related to the debt structure are compositions of the creditors like
the ratio of banks credits to total credit amounts, the share of large creditors out of total
creditors in the Agreement, etc. Relatively simple debt structure is reported to yield positive
results of working out distressed firms. The variables related to the business conditions are
the ratio of going concern business values to total assets, the ratio of going concern business
value to liquidation value, etc. The data are collected from the first due diligence report
conducted by the external auditors after the application for the Corporate Workouts.
Second, the debt restructuring variables consist of detailed actions to relieve the debt
burdens of the workout companies. Debt exemption and interest rate reduction through debt
rescheduling or changes in debt covenants, debt-to-equity conversion or debt-to-convertible
bond (CB) conversion, and additional loan provisions are some of interest. Indeed, the debt
restructuring is the core element in the Corporate Workouts. Depending on the current
conditions and future business prospects of individual ailing firms, the ways to downsize
excessive debts may take different fashions. Debt-to-equity swap is preferred to interest
relief when the business prospects are rosy with high probability. If the debtor company
faces with temporary liquidity crunch but belongs to the industry of a rising business cycle
trend, the creditors further advance fresh loans despite its currently weak financial health.
Third, the variables of the self-restructuring efforts comprise capitalization and asset
sales like real estates, businesses and subsidiaries. Usually creditors relive the debt burdens
of the workout companies on condition of the debtors’ efforts to take part in the loss sharing.
Corporate turnarounds are successful in the case of harmonious efforts by both creditors
and debtors. Then it is a reasonable guess to expect self-restructuring efforts to positively
influence the performances of the Workouts. We also look into the effectiveness of the
owners’ private properties on the revitalization of the distressed firms.
Fourth, the variables for the employment restructuring are considered. According to the
workout plan, employment downsizing and labor cost cuts are typical menus for reducing
the operating expenses and focusing on the core business areas. In view of the aspect this
paper uses three measures for the employment restructuring: changes in the number of
employees, changes in the personnel expenses and changes in the per capita personnel
12
expenses.
Finally, governance restructuring is measured with a proxy of management and
ownership reshuffling. If both management and ownership are changed in the course of the
workout process, score 1 is given to the company. If management is changed and ownership
is partly transferred to others including creditors, score 2 is given and so on up to score 6
for no change in both management and ownership. In this scoring system a priority of the
harsh governance restructuring is given to management than ownership in the context that
the former is reported to be effective in turnarounds of distressed companies. Table 3-2
summarizes the scoring system of the governance restructuring used in the analysis.
Table 3-2. Management and Ownership Reshuffling Score
Score
Changes in Management
Changes in Ownership
1
○
○
2
○
△
3
○
x
4
x
○
5
x
△
6
x
X
Note: ○ : Change,
△ : Partly change,
x : No change
The data set for these variables is constructed from various sources. The information
about the initial status of the workout companies is collected from the due diligence reports
for each company. The Corporate Restructuring Coordination Committee and Financial
Supervisory Service summarized the data on the various tools of debt restructuring and selfrestructuring efforts.9 As for the employment and governance restructuring, this paper uses
non-financial data on employment and income statements by the National Information &
Credit Evaluation, Inc. (NICE) and non-financial data by the annual business reports of the
Maeil-Kyungjae-Shinmun.
One of the deficiencies in the variables and data is lack of dynamic features of
restructuring. Due to the data availability problem this paper does not capture the
restructuring processes over time. For example, the amounts of debt-to-equity conversion
are simply aggregated without considering a discount factor. In the case of total amounts of
debt restructuring, all the components in the debt restructuring are added without taking
into account the different characteristics among debt exemption, interest relief, debt-toequity conversion, debt-to-CB conversion, etc. Management and Ownership Reshuffling
Score encounters the scale of measurement problem, for it reflects on the ordinal degree,
not the cardinal one. Despite these problems most of the aspects on the Korean Corporate
Workouts can be discussed with the variables. Table 3-3 summarizes the definition of the
explanatory variables used in the empirical analysis.
Table 3-3. Definition of the Explanatory Variables
9
The author appreciates the Financial Supervisor Service for providing the data.
13
Categories
Initial Status
Debt
Restructuring
Business
Restructuring
Employment
Restructuring
Variables
X1
X2
X3
X4
X5
X6
X7
X8
X9
X10
X11
X12
X13
X14
X15
X16
X17
X18
X19
Banks Credits / Total Credits
No. of Creditor Banks / No. of Total Creditors
No. of Over 10% Creditors / No. of Total Creditors
Top Five Creditors’ Credits / Total Credits
Going Concern Business Value / Total assets
Liquidation Value / Total Assets
Going Concern Business Value / Liquidation Value
Debt Exemption / Total Credits
Interest Relief / Total Credits
Debt-to-Equity Conversion / Total Credits
Debt-to-CB Conversion / Total Credits
X10 + X11
Total Debt Restructuring / Total Credits
Additional Credit Line / Total Credits
Real Estate Sales / Total Assets
Security Sales / Total Assets
Business Sales / Total Assets
Subsidiary Sales / Total Assets
Capitalization / Total Assets
X20
Owner’s private Contribution / Total Assets
X21
X15 + X16 + X17 + X18 + X19 + X20
X22
(X15 + X16 + X17 + X18 + X19 + X20) ·
(Total Assets/Total Credits)
X23
(Employeesend / Employeesbeginning) –1
X24
X25
Governance
Reshuffling
Definitions
X26
(Personnel Expensesend /
Personnel Expenses beginning) – 1
(Per Capita Personnel Expensesend /
Per Capita Expensesbeginning) – 1
Management and Ownership Reshuffling Score
14
3-4. Results
(1) From the Creditors’ Perspective
The Criterion 1 supplies a discrete decision rule of normalization as to whether the
workout companies are revitalized or not. If a company graduated from the program or
follows self-restructuring procedures, it is revitalized. Otherwise, it is still distressed. The
information about the revitalization or distress of the individual workout companies is
collected as entries of dependent variables in the logit regressions.
Since we have 26 explanatory variables, it may take long to obtain the best possible
combinations of regressors to forecast the corporate revitalization. Thus, before running the
logit regressions, we conduct a t-test for the explanatory variables under the Criterion 1. As
for the two different sets of companies, either revitalized or distressed, this test conveys the
information on the significance of the difference in the explanatory variables. If an
explanatory variable is significantly different in the two samples, it becomes a good
candidate for regressors in the logit model.
Table 3-4 describes the t-test results under the Criterion 1. Three initial status variables
such as the ratio of banks credits to total credits (X1), the ratio of the number of over 10%
creditors to the number of total creditors (X3), and the ratio of top five creditors’ credits to
total credits look to be different at the significance level of 5% (X4) in the two samples.
Debt-to-CB conversion out of total credits (X11) in the debt restructuring category and total
amounts of self-restructuring out of total credits (X22) in the self-restructuring one are also
significantly different at the 5% level. No variables are different with significance in the
two samples for the categories of employment and governance restructuring.
Table 3-4. t-Test Results of the Explanatory Variables: Criterion 1
Variables
t-value
p-value
Variables
t-value
p-value
X1
-2.01
0.049
X14
0.83
0.408
X2
-1.39
0.170
X15
-0.62
0.537
X3
-2.3
0.025
X16
1.08
0.286
X4
-2.27
0.028
X17
-1.02
0.311
X5
-1.37
0.179
X18
-1.31
0.195
X6
-0.64
0.527
X19
-1.54
0.129
X7
-0.89
0.380
X20
-0.13
0.901
X8
-1.37
0.177
X21
-1.6
0.115
X9
1.5
0.139
X22
-2.37
0.021
X10
-0.67
0.503
X23
-0.47
0.639
X11
2.82
0.008
X24
-1.22
0.232
X12
0.53
0.595
X25
-1.16
0.255
X13
-0.58
0.565
X26
-1.25
0.219
15
Though the t-test results provide a good starting point for constructing the explanatory
variables, the actual fitness in the logit model may be another story, especially the sign of
the coefficients. Table 3-5 reports the results of the “best” fitting regression with regressors
consisting of one from the five categories. After the iterated experiments, the best fitting
and potentially plausible results are achieved through a regression of the following
regressors: the ratio of top five creditors’ credits to total credits are different at significance
level of 5% (X4), the ratio of debt-to-CB conversion to total credits (X11), the ratio of total
amounts of self-restructuring to total credits (X22), changes in the per capita personnel
expenses (X25), and the Management and Ownership Reshuffling Score (X26).
Table 3-5. Results of the Best Fitting Logit Regression: Criterion 1
Panel A : Maximum Likelihood Estimates
Variable
Estimate
Std.error
Intercept
-4.19
1.79
Chi-Square
5.49
p-value
0.019
X4
7.44
2.82
6.94
0.008
X11
-1,209.30
468.80
6.66
0.010
X22
192.80
246.80
0.61
0.435
X25
-0.48
0.39
1.56
0.212
X26
0.26
0.17
2.39
0.122
Panel B : Model Convergence status
Criterion
Intercept only
Intercept and Covariates
AIC
81.91
62.46
SC
84.11
75.69
-2Log L
79.91
50.46
Panel C : Testing Global Null Hypothesis of coefficients = 0
Test
Chi-Square
p-value
Likelihood ratio
Wald
29.45
14.99
< .0001
0.010
Among these five explanatory variables, the first two ones are significantly different
from zero, but the last three are insignificant. This means that the initial status seems to
dominantly dictate the fate of the workout companies. The simpler the creditor structure,
the better the performances of corporate restructuring. In the case of the debt-to-CB swap,
the variable is very significant but with an opposite sign to the conventional wisdom. As
more debts are converted to debt covenants with less interest burdens (CB), the probability
that the debtor companies become revitalized is anticipated to be higher. But the actual
observation in Korea is contrary at the significance level of 1%. How can we interpret this
phenomenon? It seems that the CB conversion is conducted against the companies under
more severe distress. Since it is less likely to collect debts in this case, the financial
institutions swapped the debts into CBs that levy lower interests in return for an equity
conversion option when the debtors become performing again by any chance. In fact, the
16
CB conversion looked to be very attractive to the distressed financial institutions that could
not afford to bear the losses incurred by the debt-to-equity swap.10 In hindsight, however,
most workout companies subject to the CB conversion did not redeem the debts.
This observation is consistent to more importance of the debt-to-equity conversion
rather than the CB conversion. According to Table 3-7, the debt-to-equity conversion
variable takes a positive sign whereas most of the other ones are forecast to affect the
revitalization negatively. Thus, the debt-to-equity swap is the most prospective tool for
recovering the debts through regaining the debt payment capacity of the workout companies.
This result seems that the creditor financial institutions might exploit private information on
the probability of normalization of the firms. They were quite active in the equity
participation for good companies but passively followed the debt restructuring decision by
the Council of Creditor Committee for bad companies. The sign is correct for the debt-toequity swap, but the significance is relatively weak. Briefly put, the overall debt
restructuring instruments have not affected the performances of the Corporate Workouts
from the creditors’ perspective.
Table 3-6. Predicted Power of the Best Fitting Logit Regression: Criterion 1
Panel A : Classification Table at Probability Level 0.5
Observed
Predicted
Revitalized
Distressed
total
Revitalized
43
7
50
Distressed
5
12
17
Total
48
19
67
Panel B : Correctness at Probability Level 0.5
Value (%)
Concordant
82.1
Sensitivity
89.6
Specificity
63.2
Type Ⅰ Error
29.4
Type Ⅱ Error
14
The prediction power of the logit model under the Criterion 1 in Table 3-6 is quite
satisfactory, though it is lower than that of usual bankruptcy prediction models. At the 50%
probability level, the concordant probability of the model is 82.1%, while the sensitivity, the
ability to predict an event of revitalization correctly, and the specificity, the ability to predict
a non-event of distress correctly, reach 89.6% and 63.2%, respectively. This means that the
model predicts better for the revitalization cases than for the distress ones. The type I error,
10 At the beginning of the Workouts Program most financial institutions preferred the CB conversion to the
equity swap. In 1999, the ratio between the equity swap and CB conversion is 3 to 7. In addition to the upside
potential, the regulations on accounting principles also contributed to the preference of the CB conversion, for
the financial institutions should recognize the immediate losses for equity investments on distressed firms in
comparison with the possible deferral of losses in case of CB underwriting.
17
the proportion of predicted distress responses that were observed as revitalization, is 29.4%,
whereas the type II error, the proportion of predicted revitalization responses that were
observed as distress, is 14.0%.11
Table 3-7. Results of the Logit Regressions for Various Tools of Debt Restructuring:
Criterion 1
Debt Restructuring Variables Used in Regression
X8
X9
X10
X11
X12
X13
X14
X4
-4.35
(0.008)
6.62
(0.006)
7.10
(0.004)
7.44
(0.008)
6.50
(0.007)
6.68
(0.005)
6.53
(0.008)
X8
12,545.10
(0.981)
-61.21
(0.530)
X9
135.30
(0.314)
X10
-1209.30
(0.010)
X11
-21.53
(0.852)
X12
-36.93
(0.606)
X13
-663.50
(0.103)
X14
X22
347.70
(0.150)
290.50
(0.203)
292.60
(0.188)
192.80
(0.435)
311.50
(0.180)
295.20
(0.206)
405.00
(0.121)
X25
-0.54
(0.151)
-0.59
(0.127)
-0.62
(0.112)
-0.48
(0.212)
-0.54
(0.150)
-0.56
(0.376)
-0.42
(0.274)
X26
0.19
(0.184)
0.19
(0.190)
0.23
(0.131)
0.26
(0.122)
0.18
(0.212)
0.18
(0.147)
0.22
(0.150)
Concordant (%)
71.6
70.1
70.1
82.1
67.2
71.6
71.6
Sensitivity (%)
85.4
87.5
85.4
89.6
83.3
87.5
85.4
Specificity (%)
36.8
26.3
31.6
63.2
26.3
31.6
36.8
TypeⅠError (%)
50
54.5
53.8
29.4
61.5
50
50
TypeⅡError (%)
22.6
25
24.1
14
25.9
23.6
22.6
There have been long debates concerning the conformity of the Daewoo subsidiaries to
11
Type I and II errors are called false negative and false positive, respectively.
18
the Corporate Workouts Program. The enormous size of the Daewoo’s debts might render
its liquidation infeasible, which could make the restructuring efforts arranged by the
creditors incredible threats to the debtor. As long as the debtor holds out, the creditors
cannot impose effective tools for turnarounds. On top of the “too-big-to-close” constraint,
the Daewoo subsidiaries had very complex debt structure. They borrowed money from over
400 financial institutions both domestically and abroad. This entangled debt structure
introduced further complications in making a plan and implementing the reorganizing
strategies as planned. Additionally, the ratio of trade credits out of the entire liabilities was
so high that, once they became subject to the Corporate Workouts, the creditors had worries
about the reduced amounts of recovered credits after making full payments to the trade
credit holders.
In order to identify the legitimacy of these concerns, this paper analyzes the differences
between the two samples of Daewoo and Non-Daewoo firms. Table 3-8 displays the
comparison of the results of the logit regressions between non-Daewoo companies and
Daewoo subsidiaries. The most notable difference is that the performance of the logit model
does not produce a good prediction power in the Daewoo sample. Most of the coefficients
are so insignificant that the null hypothesis that they are individually different from zero is
rejected. The concordant ratio reaches to 50% and the specificity is only 25%. This means
that the observed distressed firms are highly likely to be predicted as revitalized. Also, the
type I error, 66.7%, is very high. Two thirds of the firms predicted as distressed are actually
revitalized. Thus, the overall forecast power of the logit model with the regressors of initial
status and restructuring variables is low in the Daewoo subsidiary case. In contrast, the
model fits well for the Non-Daewoo sample. The overall result is very similar to that of the
entire sample case with even higher prediction power and significant coefficients.
Table 3-8. Comparison of the Results of the Logit Regressions between Non-Daewoo
companies and Daewoo Subsidiaries: Criterion 1
Entire Sample
Non-Daewoo
Daewoo
-6.37
(0.020)
10.41
(0.013)
-1,190.60
(0.023)
559.20
(0.194)
-0.77
(0.120)
0.24
(0.230)
86
-32.87
(0.788)
94.40
(0.689)
42,469.80
(0.869)
-31,020.60
(0.647)
8.60
(0.867)
Concordant (%)
-4.19
(0.019)
7.44
(0.008)
-1,209.30
(0.010)
192.80
(0.435)
-0.48
(0.212)
0.26
(0.122)
82.1
Sensitivity (%)
89.6
92.9
66.7
Specificity (%)
63.2
66.7
25
TypeⅠError (%)
29.4
23.1
66.7
TypeⅡError (%)
14
11.4
42.9
Intercept
X4
X11
X22
X25
X26
50
The last experiment is carried out on industries. It has been argued that corporate
19
workouts seem to be suitable for the manufacturing firms. In general, core competence of
the construction companies consists of intangible assets like management and design skills,
reputation or brand name, and experiences. Then the construction companies are more
likely to lose the intangible assets once they become financially distressed. It is very
difficult for them to regain competence and reputation and also to retain professionals. In
addition, most of their tangible assets are based on installment plans or lease. Due to these
characteristics of the construction companies, restructuring specialists did not agree on the
affiliation of the construction companies to the Corporate Workouts Program. Table 3-9
assures this argument. There do not exist clear influences of restructuring efforts on the
performances of the workout construction companies like the Daewoo subsidiaries. Every
coefficient is not significant and the prediction power of the logit model with regressors of
the restructuring variables as well as the initial status ones is very weak.
Table 3-9. Results of the Logit Regressions for Manufacturing and Construction:
Criterion 1
Entire Sample
Manufacturing
Construction
-4.19
(0.019)
7.44
(0.008)
-1,209.30
(0.010)
192.80
(0.435)
-0.48
(0.212)
0.26
(0.122)
-4.96
(0.030)
7.99
(0.027)
-845.40
(0.045)
467.10
(0.204)
-0.64
(0.158)
0.23
(0.274)
-23.36
(0.889)
81.05
(0.868)
-28,089.90
(0.700)
-17,049.10
(0.834)
26.40
(0.825)
6.29
(0.762)
Concordant (%)
82.1
83
50
Sensitivity (%)
89.6
90.9
40
Specificity (%)
63.2
64.3
60
TypeⅠError (%)
29.4
25
50
TypeⅡError (%)
14
14.3
50
Intercept
X4
X11
X22
X25
X26
(2) From the Debtors’ Perspective
The Criterion 2 in the subsection 3.2 contains a flavor of the performances of corporate
restructuring from the debtors’ point of view. In order to get revived, the distressed
companies should be back to the state of normal business operations. All of the corporate
turnaround tools like reducing the debt burdens, asset sales, management reshuffling are
focused on the debtors’ regaining the confidence in the core business areas to strengthen the
debt service capacity from the creditors’ point of view. The ultimate goal and interests of
20
the debtors, however, hinge on their profit maximization. If the debtor companies become
performing to the extent in which they pay back the principal and interests to the creditors
and the return on investment is not enough relative to the available interest rates, they have
few incentive to become alive. As a matter of fact, their revitalization turns out to serve only
the creditors. In this sense the revitalization from the creditors’ perspective is different from
the debtors’.
Using the ratio of operating profits to interest expenses, this paper divides the workout
companies into two groups: revitalized or distressed ones. As for the two groups, the t-test
is conducted to get hunches for the effective explanatory variables for the logit analysis.
Table 3-10 summarizes the results. Only two variables are significantly different in the two
groups: the ratio of the number of over 10% creditors to the number of total creditors (X3)
and the ratio of the going concern business value to total credits (X5). Also, another initial
status variable, the ratio of the liquidation value to total credits (X6), and one of the
employment restructuring variable, changes in the per capita personnel expenses (X25),
show the significance around the 5% level. The main message of the t-test results is that the
initial status of the workout companies may almost determine the success of business
turnarounds. Other detailed restructuring efforts by both the creditors and debtors seem to
be dominated by the initial conditions.
Table 3-10. t-Test Results of the Explanatory Variables: Criterion 2
Variables
t-value
p-value
Variables
t-value
p-value
X1
-0.25
0.802
X14
0.79
0.431
X2
-1.56
0.119
X15
-0.74
0.462
X3
-2.18
0.035
X16
-0.57
0.573
X4
-1.28
0.206
X17
1.41
0.164
X5
-2.05
0.045
X18
1.23
0.225
X6
-1.94
0.057
X19
-0.95
0.348
X7
-0.65
0.519
X20
-0.55
0.586
X8
-1
0.326
X21
0.48
0.630
X9
1.36
0.178
X22
0.87
0.390
X10
-0.27
0.787
X23
-2.21
0.033
X11
0.7
0.487
X24
-0.4
0.692
X12
-0.02
0.982
X25
1.94
0.057
X13
0.55
0.583
X26
0.95
0.347
Table 3-11 is the summary statistics of the “best” fitting logit regression for the entire
sample under the Criterion 2. Note, first, that the relevant explanatory variables for this
regression under this criterion are different from those under the Criterion 1. The significant
initial status variables are different, but they are in the same vein in that X3 and X4 describe
the creditor structure. Again, the simpler the creditor structure is, the better the
21
performances of corporate restructuring is. X5 draws a notable attention in the sense that the
value of the firm at the time of starting the workouts is important in corporate rehabilitation,
though it is not so significant. Under the Criterion 1, this variable was less important.
Among the debt restructuring variables, the ratio of interest relief to total credits (X9) is
significantly different from zero, but it takes an opposite sign. As more interest burdens are
relieved, the probability of revitalization becomes slim, which is contrary to the
conventional wisdom. This result may stem from passive debt relief of the creditors against
the less prospective companies. That is to say, the debt reduction did not reflect on the
debtors’ position. Indeed, the creditor financial institutions did not take into much account
the debtors’ long-term viability under the circumstances where they were on the verge of
closing the business due to capital inadequacy. According to Table 3-13, other debt
restructuring tools except for the debt-to-equity conversion (X10) are not effective on the
corporate revitalization. Thus, the results from Table 3-7 and Table 3-13 support the
importance of the debt-to-equity conversion from the standpoint of both creditors and
debtors. The self-restructuring efforts by the workout companies turn out to be ineffective
on the performances of the workout companies in terms of business normalization.
According to Table 3-14, all of the variables in this category are insignificant. In most cases,
the coefficients have opposite signs as well.
Table 3-11. Results of the Best Fitting Logit Regression: Criterion 2
Panel A : Maximum Likelihood Estimates
Variable
Estimate
Std.error
Chi-Square
p-value
Intercept
X3
X5
X9
X17
X25
X26
0.22
9.80
1.22
-324.00
-1.46
-0.59
-0.18
1.15
4.11
0.83
145.90
4.76
0.47
0.16
0.04
5.68
2.16
4.93
0.09
1.57
1.36
0.844
0.017
0.142
0.026
0.759
0.210
0.244
Panel B : Model Convergence status
Criterion
Intercept only
Intercept and Covariates
AIC
SC
-2Log L
85.11
87.21
83.11
76.13
90.79
62.13
Panel C : Testing Global Null Hypothesis of coefficients = 0
Test
Chi-Square
p-value
Likelihood ratio
Wald
20.98
11.30
0.002
0.080
Insignificant as they are, the variables of the employment restructuring and management
22
reshuffling in Table 3-11 take plausible signs. As the pressure gets harsher on the labor
restructuring and responsibility of the management for distress, the workout companies tend
to have more chance to achieve normal business operations. Here the management and
ownership reshuffling is especially interesting. The change in the management and
ownership should be definitely a bad news for the incumbent, but could be a good news for
the company itself. In such a case the incumbent managers and owners may have incentives
to cooperate with the creditors for the purpose of maintaining their positions. Then the
creditors would benefit from guaranteeing the incumbent’s positions by maximizing the
debt recovery. The costs from the mutual benefits of the creditors and the incumbent
managers and owners will be attributable to the companies, resulting in further distress in
terms of business operations.
Finally, Table 3-12 point out that the prediction power of the logit model under the
Criterion 2 is weaker than that under the Criterion 1. The concordant percentage is 63.3% at
the probability level of 0.5. Sensitivity and specificity are low and both type I and II errors
are relatively high.
Table 3-12. Predicted Power of the Best Fitting Logit Regression: Criterion 2
Panel A : Classification Table at Probability Level 0.5
Observed
Predicted
revitalized
distressed
total
revitalized
18
11
29
distressed
11
20
31
total
29
31
60
Panel B : Correctness at Probability Level 0.5
Value (%)
Concordant
63.3
Sensitivity
62.1
Specificity
64.5
Type Ⅰ Error
35.5
Type Ⅱ Error
37.9
3-5. Summary of the Empirical Results
Based on the observations from the two kinds of regressions from the creditors’ and
debtors’ perspectives, we can make the following remarks as evidence on the performances
of the Korean Corporate Workouts. First, the initial status variables are the key success
factors in the Corporate Workouts. The ratio of top five creditors’ credits to total credits is
found as the most significant factor to affect the revitalization of the workout companies in
terms of debt service capacity. Also, as the ratio of over 10% creditors to total creditors
23
becomes higher, the distressed companies are more likely to recover business operations.
Namely, the debt structure of the workout companies has dominated various restructuring
efforts. The importance of simple debt structure in the Workouts is consistent to the analysis
by Gilson, John and Lang (1990) that the private workouts did not perform well in the U.S.
companies that had a host of creditors due to bond issuance in the markets.
Table 3-13. Results of the Logit Regressions for Various Tools of Debt
Restructuring: Criterion 2
Debt Restructuring Variables Used in Regression
X3
X5
X8
X8
X9
X10
X11
X12
X13
X14
5.95
(0.056)
1.01
(0.180)
14,559.60
(0.987)
9.80
(0.017)
1.22
(0.142)
7.36
(0.036)
1.05
(0.176)
5.39
(0.092)
1.18
(0.143)
7.24
(0.047)
0.99
(0.193)
6.22
(0.050)
1.13
(0.153)
6.62
(0.040)
1.04
(0.172)
-324.00
(0.026)
X9
115.90
(0.373)
X10
-350.30
(0.375)
X11
79.27
(0.542)
X12
-37.10
(0.569)
X13
0.45
(0.922)
-0.57
(0.193)
-0.17
(0.250)
-1.46
(0.759)
-0.59
(0.210)
-0.18
(0.244)
0.04
(0.994)
-0.55
(0.219)
-0.14
(0.327)
-0.50
(0.918)
-0.55
(0.216)
-0.14
(0.324)
0.43
(0.928)
-0.57
(0.198)
-0.15
(0.294)
0.51
(0.914)
-0.66
(0.164)
-0.17
(0.237)
273.10
(0.489)
1.17
(0.807)
-0.67
(0.143)
-0.17
(0.246)
Concordant (%)
60
63.3
58.3
60
58.3
58.3
60
Sensitivity (%)
51.7
62.1
51.7
55.2
51.7
51.7
55.2
Specificity (%)
67.7
64.5
64.5
64.5
64.5
64.5
64.5
TypeⅠError (%)
40
35.5
41.2
39.4
41.2
41.2
39.4
TypeⅡError (%)
40
37.9
42.3
40.7
42.3
42.3
40.7
X14
X17
X25
X26
Table 3-14. Results of the Logit Regressions for Various Tools of Self-Restructuring:
24
Criterion 2
Self-Restructuring Variables Used in Regression
X3
X5
X9
X15
X15
9.91
(0.015)
1.15
(0.170)
-318.80
(0.027)
2.57
(0.574)
X16
10.87
(0.012)
1.26
(0.124)
-366.20
(0.018)
X17
9.80
(0.017)
1.22
(0.142)
-324.00
(0.026)
X18
10.18
(0.017)
1.41
(0.096)
-345.80
(0.021)
X19
10.40
(0.016)
1.37
(0.106)
-346.40
(0.027)
X20
10.08
(0.015)
1.12
(0.209)
-330.30
(0.022)
X21
9.90
(0.017)
1.28
(0.139)
-333.50
(0.025)
X22
9.85
(0.017)
1.34
(0.163)
-336.30
(0.026)
10.01
(0.330)
X16
-1.46
(0.759)
X17
-6.65
(0.248)
X18
-2.30
(0.690)
X19
9.10
(0.677)
X20
-32.36
(0.848)
X21
-0.71
(0.140)
-0.21
(0.170)
-0.60
(0.170)
-0.21
(0.181)
-0.59
(0.210)
-0.18
(0.244)
-0.76
(0.109)
-0.17
(0.261)
-0.63
(0.158)
-0.20
(0.189)
-0.67
(0.139)
-0.20
(0.185)
-0.63
(0.161)
-0.17
(0.298)
-0.47
(0.830)
-0.62
(0.168)
-0.17
(0.292)
Concordant (%)
63.9
67.2
63.3
63.9
60.7
63.9
64.4
64.4
Sensitivity (%)
58.6
62.1
62.1
62.1
55.2
58.6
62.1
62.1
Specificity (%)
68.8
71.9
64.5
65.6
65.6
68.8
66.7
66.7
TypeⅠError (%)
35.3
32.4
35.5
34.4
38.2
35.3
35.5
35.5
TypeⅡError (%)
37
33.3
37.9
37.9
40.7
37
35.7
35.7
X22
X25
X26
Second, the debt-to-equity conversion is the most effective tool among various debt
restructuring methods, though it does not seem to be very significant. Other ways to relieve
the debt burdens of the workout companies had affected the corporate revitalization in the
opposite direction to the conventional wisdom. Especially, the debt-to-CB conversion has
affected the capability of the distressed companies to redeem debts adversely in a very
25
significant manner. These observations can be understood as the result of the creditor-led
corporate restructuring. As mentioned earlier, the Korean Corporate Workouts Program
aimed mainly at restructuring the distressed financial institutions. Corporate restructuring
was a supplementary instrument with which they tried to boost up the recovery of the NPLs
from the corporate sector. Thus, the amounts of the debt restructuring should be provided as
little as possible in a conservative fashion that enabled them to minimize the losses. The
positive correlation of the debt-to-equity swap with the corporate revitalization from the
creditors’ perspective is thought to be the sorting results of the financial institutions, of
which the private information set is larger than that of the publicly available information.
They had converted the debts into equities only for the prospective companies.
Third, the business and employment restructuring turns out to be insignificant in
corporate revitalization. As for almost all of the proxy variables for these categories, the
null hypothesis that the coefficient is zero cannot be rejected. Only in the results of the
business rehabilitation from the debtors’ perspective, per capita personnel expenses, one of
the employment restructuring variables, are relatively significant and consistent.
Fourth, it is quite delicate to interpret the effect of the governance reshuffling on the
performances of the Workouts. Under the criterion reflecting creditors’ position, this
variable is quite significant, but in the reverse way. The harsher the management and
ownership reshuffling is, the worse the recovery of debt service capacity is. Under the
criterion reflecting debtors’ position, however, it is less significant, but in the consistent way.
The harsher the management and ownership reshuffling is, the better the business
operations are. One of the possible explanations for this phenomenon is that the creditors
and managers of the workout companies may collude with each other for the sake of their
own incentives. Their incentives are quite clear. The creditors hoped to maximize the
recovery, while the managers were eager to retain their positions. If they behave as their
incentives dictate, the empirical observations forecast that the debt service capacity would
increase while the distressed companies would be less likely to be back in normal business
conditions. This is just a conjecture, so that further research should verify the true
relationship between the governance reshuffling and corporate revitalization.
Fifth, the prediction power of the logit model for the samples of the Daewoo subsidiaries
and firms in the construction industry is very weak. Namely, the variables used in the
analysis did not explain the binary responses of the Corporate Workouts against these firms.
This observation can be interpreted in many ways. One may argue that the private workouts
are not suitable for these cases. Due to their complex debt structure and/or size of
businesses formal bankruptcy filings should have been imposed if there had not been
concerns over the occurrence of a systemic crisis. Some may argue that the low prediction
power does not necessarily imply the ineffectiveness of the workouts against these firms.
The unsatisfactory performance of the logit model may stem from the different
characteristics of the companies in these samples. Then individually tailored restructuring
could be still effective, whereas statistical generalization may not be feasible.
4. Performances of the Workout Companies from 1995 to 2002
We have seen the factors that affected the performances of the workout companies in the
Section 3. This section discusses their overall performances in view of the financial
statements well before the crisis and up to the present. Focusing on the main business
activities, this paper compares the financial ratios among the four categories of the workout
companies by results: graduation, self-restructuring, in-progress, and suspension.
Additionally, we look into the difference in the measures between the Daewoo subsidiaries
and non-Daewoo workout firms.
26
Table 4-1 reports the core statistics of the balance sheet and income statements of the
entire non-financial workout companies in an aggregate manner from 1995 to 2002. The
growth of total assets until 1998 is remarkably high. During the four years, the total asset
had increased two fold. The growth rate of total liabilities is even higher. During the same
period, the total liabilities had blown up nearly two and half times. In contrast, the equities
had increased at a lower growth rate, 12.3% per year. Thus, overall financial health of the
workout companies had deteriorated.
On the profit and loss side, the business of the workout companies also got worse.
Operating profits were growing before the crisis, but interest expenses were increasing at
faster speed. Thus, net profits had already started to decline well before the crisis and turned
into losses in 1997. In 1998 the operating profits of the aggregate workout companies are
positive, but should have been recorded as losses in view of huge misreporting of the
Daewoo. In fact, the non-Daewoo workout companies incurred losses in core business
operations in 1998.
Table 4-1. Summary of the Financial Statements of the Non Financial Workout
Companies
(unit: KRW 1 billion)
1995
B/S
1996
1997
1998
1999
2000
2001
2002
Total Assets
53,370 62,603 84,167 109,332 84,850 55,692 50,151 38,836
Liquid Liabilities
26,149 29,248 42,288 51,472 47,986 40,989 23,651 15,473
Fixed Liabilities
15,649 20,596 26,753 41,337 54,749 47,950 61,877 41,527
Total Liabilities
29,388 34,626 50,578 72,741 72,224 59,699 42,642 40,612
Total Equities
11,572 12,759 14,771 16,397 -17,885 -33,247 -35,378 -18,165
Sales
45,280 56,954 69,528 79,388 63,987 47,802 43,671 44,114
Operating Profits
3,179
3,822
4,837
2,083 -10,345
Interest Costs
3,127
3,765
4,937
9,372
384
138
-482
-1,980
1,276
1,443
7,732
7,696
5,751
P/L
Net Profits
Ratio
9,343
-8,025 -37,487 -19,607
-7,042 13,259
Operating Profits /
Interest Costs
1.017
1.015
0.980
0.222
-1.107
-0.256
0.166
0.251
Operation Profits /
Total Assets
0.060
0.061
0.057
0.019
-0.122
-0.036
0.025
0.037
Operating Profits /
Sales
0.070
0.067
0.070
0.026
-0.162
-0.041
0.029
0.033
After the Corporate Workouts were commenced, enormous restructuring efforts began to
27
be shown on the financial statements. The size of total assets has decreased dramatically.
Liquidity became dried up due to redemption of the debts and the maturity extension of the
short-term debts, while fixed liabilities increased until 2001. As the companies paid back
the long-term debts, the fixed liabilities declined. The revelation of hidden distress and the
pressure from the creditors on debtors’ loss recognition in the course of restructuring
pushed the equity amounts downward. The workout companies on average became
insolvent from 1999, which is still persisting. The enormous debt-to-equity conversions,
which were planned in 2000 and 2001 but executed mostly in 2002, turned the financial
health in a positive direction. The Corporate Workouts have affected the business activities
very much. In general, financial distress curtails the scope and size of businesses.
Additionally, the business restructuring efforts like the sales or spin-off of businesses and
liquidation of unprofitable and sunset companies have had the total sales shrunk. Even if the
sales were reduced, the operating profits (or losses) started to grow (or decrease)
immediately after being under the Workouts Program. This is because the companies
adjusted the target to maximizing profits after realizing the existing and potential messes.
Figure 4-1 shows the operating profits relative to the interest expenses for the different
groups of the workout companies by the workout results as well as the average of the entire
corporations subject to the external auditing. Since the workout companies are financially
and operationally distressed, the average of the entire corporations outperforms them. The
ratio of the operating profits to the interest expenses in the entire companies has always
been higher than that of the workouts companies. Among the categories of the workout
companies, the order of the performances in terms of the ratio is consistent to the decisions
by the Council of Creditor Financial Institutions. The graduated companies and the ones
under the self-restructuring plan started revitalized just after the initiation of the Corporate
Workouts. In the case of the still distressed categories like suspension and in-progress, their
financial statements improved only temporarily due to debt restructuring, which was not
sustained by business operations. After the creditors stopped managing these companies in
2001, their performances deteriorated. Note that the big downward hump in the case of
suspended companies takes place due to the liquidation type of the Daewoo subsidiaries
like the old-Daewoo Corp. and the old-Daewoo Heavy Industry after the partitions. Figure
4-2 shows the difference between the Deewoo and the non-Daewoo workout companies.
One of the interesting observations in these two graphs is that the effect of the Corporate
Workouts is quite persistent. Since the Corporate Workouts consists of tedious examinations,
negotiations, monitoring and revisions of workout plans, the effect is not speedy unlike the
formal bankruptcy filings. 12 As more restructuring tools are introduced, not only the
financial capacity of servicing the debts is improved but also business operations get
vigorous over time.
12 See Kim (2003) for the comparisons of performances among corporate reorganization, composition and
the Workouts.
28
Figure 4-1. The Ratio of Operating Profits to Interest Expenses by Categories
of the Workouts Results: 1995-2002
2.5
2
1.5
1
0.5
0
-0.5
-1
-1.5
-2
-2.5
1995
1996
1997
Corporate Average
1998
Graduation
1999
Self-Restructuring
2000
In-Progress
2001
2002
Suspension
Figure 4-2. The Ratio of Operating Profits to Interest Expenses between
Daewoo and Non-Daewoo: 1995-2002
2.5
2
1.5
1
0.5
0
-0.5
-1
-1.5
-2
1995
1996
1997
1998
Corporate Average
1999
Daewoo
2000
2001
2002
Non-Daewoo
29
Figure 4-3 displays the ratio of the operating profits to the total assets. The various
groups had been indiscriminant before the financial crisis. However, this ratio for the
workout companies precipitated around the crisis and got recovered gradually after the
initiation of the Corporate Workouts. The gap of this ratio between the entire corporations
and the workouts companies is narrower than that of the ratio of the operating profits to the
interest expenses, for the latter captures the debt restructuring only while the former reflects
on the self-restructuring efforts as well. Figure 4-4 shows the difference between the
Daewoo subsidiaries and the non-Daewoo workout companies. It is noticeable that before
the crisis the Daewoo affiliated firms seemingly outperformed the average corporations. In
view of enormous misreporting in the accountings might exaggerate the actual
performances of the Daewoo’s.
Figure 4-3. The Ratio of Operating Profits to Total Assets by Categories of the
Workouts Results: 1995-2002
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
-0.25
-0.3
1995
1996
Corporate Average
1997
1998
Graduation
1999
Self-Restructuring
2000
In-Progress
2001
2002
Suspension
Finally, Figure 4-5 demonstrates the ratio of the operating profits to total sales. This
variable focuses more on the business aspect aside from the financial strength. The
graduated workout companies are almost equivalent to the average corporations in terms of
this measure. This means that, although the graduated workout companies have relatively
more burdens on the interest payments than the average firms, their business operations has
already come back to the normal states. Thus, we can expect these firms to have more
chances to record better performances in the future.
30
Figure 4-4. The Ratio of Operating Profits to Total Assets between
Daewoo and Non-Daewoo: 1995-2002
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
-0.25
1995
1996
1997
1998
Corporate Average
1999
Daewoo
2000
2001
2002
Non-Daewoo
Figure 4-5. The Ratio of Operating Profits to Total Sales by Categories
of the Workouts Results: 1995-2002
0.15
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
-0.25
-0.3
-0.35
1995
1996
Corporate Average
1997
1998
Graduation
1999
Self-Restructuring
2000
In-Progress
2001
2002
Suspension
31
Figure 4-6. The Ratio of Operating Profits to Total Sales between
Daewoo and Non-Daewoo: 1995-2002
0.1
0.05
0
-0.05
-0.1
-0.15
-0.2
-0.25
-0.3
1995
1996
1997
1998
Corporate Average
1999
Daewoo
2000
2001
2002
Non-Daewoo
In terms of the above three measures the Daewoo subsidiaries are far behind the nonDaewoo workout companies. These observations could be understood as the results from
the late affiliation of the Daewoo with the Corporate Workouts and from the initial depth of
distress.13 Since the restructuring effects tend to occur over long periods of time, we may
guess that the performance of the Daewoo will get better. The complex debt structure of the
Daewoo may also ask for more time to identify the results. Nevertheless, the distress of the
Daewoo before entering into the Workouts was so deep that its performance may encounter
limitations.
5. Conclusion
The Corporate Workouts Program in Korea is one of the desperate attempts to overcome
the unprecedented difficulties brought about by the financial crisis. At first glance this
program looks to be an ordinary corporate restructuring, but has more flavors of financial
restructuring. In general, financial institutions produce semi-public goods, whereas
individual companies do private ones. If the financial system does not function properly due
to bank failures, no one is willing to bear the costs except for the government, even though
the entire nation would benefit from its resumption. Because of market failure in this public
goods sector after the crisis, the imminent policy was rightly focused on rehabilitating
banking sector, including deeply problematic merchant banks, and then non-bank financial
intermediaries. Financial restructuring was involved in disposing of non-performing assets
and other business restructuring. During this process, financial institutions should incur so
huge losses that they could not absorb with their own capital. Non-viability of financial
institutions, which were major creditors to the workout applicants, led to define the
13 The depth of the Daewoo’s distress can be identified with the KAMCO’s purchasing price of the nonperforming assets.
32
properties of the Korean Corporate Workout Program as a part of financial sector
restructuring. Thus, the policy evaluations on the Corporate Workouts ought to consider this
characteristics.
Based on this understanding, this paper tries to identify the factors affecting the
performances of the Corporate Workouts from both creditors’ and debtors’ perspectives.
The prime results through empirical analyses are summarized as follows. First, the initial
conditions on the debt structure of the workout companies are significantly related to the
revitalization from both creditors’ and debtors’ point of view. Second, the debt restructuring
instruments are insignificant in the success of corporate turnarounds, but the debt-to-equity
conversion has been relatively effective. Third, the self-restructuring efforts, employment
downsizing and governance reshuffling do not affect the performances significantly.
According to the data on the financial statements, the successfully reorganized
companies under the Workout Program have shown good performances in debt service
capacity and business operations. The program has also helped the creditor financial
institutions raise the recovery rate of delinquent debts. Briefly put, it has contributed to
overcoming the crisis through micro restructuring in financial and corporate sectors. More
importantly, the Korean Corporate Workouts Program has taught every economic agent the
restructuring culture, which may reduce both the odds and costs of the probable crises in the
future.
33
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