Chapter 1 edited / Corporate Restructuring / p. 1
Chapter 1
Corporate Restructuring: An Overview
The financial crises of the late 1990s devastated emerging-market economies and presented
considerable obstacles to achieving a sustainable recovery. The rises in unemployment, sharp
jumps in interest rates, double-digit declines in output, and plummeting exchange rates
engendered considerable suffering, enormous shifts in the profitability of business activities, and
a massive overhang of bankrupt corporations and bad loans on the balance sheets of banks. The
scope of banking and corporate sector difficulties dwarfed the financial and human resources
available to devote to their resolution. In some countries, effective laws, strong institutions, and
decisive government leadership combined to recognize losses quickly, limit the overhang of
impaired bank assets, and make progress in resolving corporate distress. In other countries,
archaic laws and weak institutions and leadership compounded the problems, slowing economic
recovery and increasing the ultimate fiscal costs of the crisis.
The key role of the corporate sector in precipitating the East Asian crises and the
fundamental importance of corporate sector restructuring to the health of the banking system and
the achievement of sustainable recovery have focused attention on the role of public policy
responses in corporate restructuring. Nevertheless, detailed information on the steps that
governments have taken to remedy systemic corporate distress remains limited. Policymakers,
regulators, bankers, restructuring specialists, and corporate managers confronting financial crises
require answers to numerous questions of policy and implementation that may be informed by
past experience. For example, what are the “best practices” for regulatory measures? Should
governments establish asset management companies to take over impaired loans? How should
chapter 1 overview edited / corporate restructuring / p. 2
out-of-court workout procedures be structured? What techniques have proven effective in
restructuring distressed firms?
This volume relies on the experience of senior public officials, private businessmen, and
staff of the World Bank and International Monetary Fund (IMF) involved in corporate
restructuring to address these questions. The papers that follow were commissioned as part of a
World Bank seminar on Corporate Restructuring: International Best Practices, held in
Washington, D.C. in March 2004. In this initial chapter, we touch on the major issues raised in
papers and oral presentations given at the conference. The subjects addressed can be grouped
into efforts to monitor corporate sector vulnerability; the legal, regulatory, and policy responses
to systemic corporate crises; and financial restructuring techniques used to deal with insolvent
companies.
[1] Monitoring Systemic Corporate Sector Vulnerability [end]
The conference began with Jack Rodman’s overview of progress in reducing banks’
nonperforming loans, set out in chapter 2. Asian economies have cut the volume of
nonperforming loans in half over the past two years, mostly through write-offs and transfers to
government agencies rather than through disposition of assets. Rodman discusses the main
requirements for reducing nonperforming loans: strong government leadership and the
willingness to take difficult regulatory actions are essential, and the provision of working capital
to special asset management companies can be an important indicator of government
commitment. Governments can substantially reduce the costs of resolving nonperforming loans
by clarifying the legal structure for transactions such as trusts for securitization, strengthening
chapter 1 overview edited / corporate restructuring / p. 3
creditor rights and the role of the court system, opening the market to foreign competition, and
encouraging a wide range of instruments for selling nonperforming loans (for example, assetbacked securitizations and joint ventures). Governments also have to face reality about the need
to use taxpayers’ money to achieve progress in reducing nonperforming loans. Rodman cites the
example of Japan, where nonperforming loans were held on bank books for a decade until the
government decided to take strong measures and use government funds.
In numerous instances, government asset management companies and banks exhibited
timidity in recognizing the market value of assets and therefore opted to warehouse assets rather
than dispose of them quickly. Sellers of nonperforming loans need to have a realistic
understanding of asset values and the capacity to absorb losses. A bank may retain a
nonperforming loan in the expectation of making a relatively large recovery in the future, but in
the meantime its ability to make other loans is impaired because its troubled balance sheet makes
it difficult to raise new capital. And while time passes, the value of the asset may deteriorate.
Professionals hired to dispose of nonperforming loans cannot be held accountable for losses that
were inherent in the system before they acquired the loan. For example, Malaysia’s Danaharta
was successful because it acquired nonperforming loans at market prices and disposed of them as
quickly as possible.
Although they are not able to predict accurately the timing of crises, econometric models
can be useful in measuring vulnerability to a crisis. Most research focuses on macroeconomic
variables such as the level of international reserves, the real exchange rate, or credit growth. For
instance, Kaminsky, Lizondo, and Reinhart (1997) distinguish four broad approaches to
empirical work on crisis prediction: (a) qualitative discussions, (b) examination of stylized facts,
(c) individual and multicountry panel studies testing theoretical models, and (d) evaluations of
chapter 1 overview edited / corporate restructuring / p. 4
the usefulness of leading indicators. Less extensive cross-country work has been done in
identifying corporate sector indicators that are useful predictors of crises in emerging markets.
The conference helped to fill this gap with papers by Jack Glen (chapter 3) and by Michael
Gapen, Dale Gray, Cheng Hoon Lim, and Yingbin Xiao (chapter 4).
Glen proposes the interest coverage ratio (ICR—the ratio of earnings, before interest,
taxes, and depreciation expense, to interest expense) as a measure of firm viability: firms with a
ratio below 1 do not generate adequate cash flow to service their debt. He analyzes the
relationship between the ICR and factors specific to the firm, as well as macroeconomic events,
for a large number of firms in a broad cross section of countries during the period 1994–2001.
After controlling for firm, sector, and country fixed effects, he demonstrates a strong link
between the macroeconomic environment and a firm’s ability to service its debt. This is not
surprising. The paper adds an important dimension to our understanding of the dynamics of the
crisis in Thailand by identifying how much deterioration one would expect from any given level
of change in the economic environment. For every 10 percentage point decline in GDP growth,
the ICR drops about 1 percentage point. For example, the 16 percent drop in Thailand’s GDP
from 1996 to 1998 would, by these estimations, have doubled to about 25 percent the share of
Thai firms with an ICR of less than 1.
An interesting conclusion from the paper is that creditor rights have a large impact on a
country’s average ICR. Creditor rights are defined by an index ranging from 1 to 4, with higher
values indicating stronger creditor rights. Glen finds that a movement of one unit in this index
increases the average ICR in a country by 0.83. Apparently, better creditor rights induce firms to
be more conservative in their capital structure.
chapter 1 overview edited / corporate restructuring / p. 5
In chapter 4, Gapen and his co-authors estimate corporate sector credit risk using the
contingent claims approach, a concept widely applied by financial market participants to
measure the default probability of a firm. The contingent claims approach uses options theory to
measure the value of the firm in terms of the market price of securities in the capital structure
(because equity can be thought of as a residual claim with limited liability, there is a
correspondence between equity and a call option). The authors compute the distance to distress,
which is the difference between the implied market value of firm assets and an indicator of the
level of debt, scaled by a one standard deviation move in firm assets. This model would have
provided an accurate view of the pending financial difficulties facing the Brazilian corporate
sector in the buildup to the crisis and would have signaled serious problems for many Thai firms
nearly 18 months before the floating of the baht.
The authors also point out that a complete analysis of the risks involved in corporate
sector vulnerabilities must take into account third-party guarantees, such as government
guarantees of the financial system. In Brazil, use of the contingent claims approach to estimate
convertibility risk appears to explain some of the rationale behind capital outflows and corporate
sector behavior during the second half of 2002. In Thailand, the contingent claims methodology
shows that the likely cost to the government of financial sector guarantees rose markedly during
the crisis, reaching between 30 and 40 percent of GDP by October 1997. Subsequent
restructurings in the financial sector indicate that this estimate was relatively accurate.
The final perspective on detecting systemic corporate vulnerability comes from one of the
few government agencies in the developing world devoted specifically to monitoring corporate
sector vulnerability on a permanent basis. In chapter 5, Rodolfo Danies Lacouture discusses the
activities of Colombia’s Superintendency of Companies, established to monitor and, as
chapter 1 overview edited / corporate restructuring / p. 6
warranted, intervene in businesses with the goal of preventing crises, ensuring confidence in the
legal system, and generating reliable accounting data. The Superintendency of Companies
reviews companies, on its own initiative or at the request of a minority shareholder, to evaluate
the company’s legal, accounting, economic, and administrative status. If a company is subject to
significant problems, the superintendency first provides support by reviewing annual business
plans and monitoring quarterly information to see if progress is being made. For companies
found to be in violation of public order—for example, officers have committed fraud or the
company is in immediate risk of insolvency—the superintendency may remove management,
impose fines, and, in the extreme case, order liquidation of the company. The superintendency is
also charged with establishing the legal process for restructuring and bankruptcy and may act as
the judge in bankruptcy proceedings.
The superintendency has focused on gathering information on companies and overseeing
insolvency proceedings. Almost 2,500 companies have been subject to special follow-up because
they were in a critical financial situation, and the superintendency is seeking to reach
restructuring agreements for companies that handle 1.1 billion pesos in assets and have 2,000
jobs at risk. The superintendency also has developed a diagnostic index program to evaluate
company operations. The program (available on the Internet) helps companies to benchmark
their performance relative to a peer group and to identify the risks they confront. This preventive
system has reaped significant advantages over the past three years, contributing to a sharp
decline in the number of companies entering into restructuring agreements or mandatory
liquidation.
chapter 1 overview edited / corporate restructuring / p. 7
[1] Legal, Regulatory, and Policy Responses to Systemic Corporate Crises [end]
A strong bankruptcy framework is critical to the investment climate and the efficiency of capital
markets. If, in the event of adversity, creditors lack assurance of being able to recover collateral
or salvage a portion of their loan, they will reduce the volume of their lending, restrict lending to
borrowers who hold collateral that can be repossessed easily, or raise the interest rate. Thus the
allocation of capital will be less efficient, and the volume of investment lower, than would be
possible with an effective bankruptcy framework. This framework has several aspects, including
the administrative efficiency of courts (for example, whether cases are considered expeditiously),
the impartiality and expertise of judges (whether judges are honest and knowledgeable about
commercial law and business realities), the consistency of court decisions (whether the outcome
of disputes is predictable), the supply of competent accountants and the use of acceptable
accountancy principles, and the appropriateness of the laws and regulations governing
bankruptcy (for example, whether they are balanced and not overly weighted to either debtor or
creditor interests or are consistent with efforts to maintain bankrupt firms as a going concern,
where feasible). While several countries took steps following systemic crises to improve the laws
governing bankruptcy, reforms to enhance the capacity and expertise of the bankruptcy process
proved more elusive.
The appropriate structure of bankruptcy law in industrial economies is evolving with the
level of economic development. As James Zukin writes in chapter 9, earlier bankruptcy regimes
emphasized tangible property rights, the rights of secured creditors, and the realization of assets
to discharge debts. However, in modern economies, the value of the firm as a going concern
chapter 1 overview edited / corporate restructuring / p. 8
often exceeds the value of tangible assets, due to advantages such as human resources,
organization, and brand-name recognition. Thus modern bankruptcy regimes, as exemplified by
the U.S. Chapter 11 system, emphasize maintaining firms as going concerns, with provisions for
stays on litigation, standstill agreements, debtor-in-possession financing, negotiations to achieve
workable reorganizations, and cram-down of majority-approved agreements on minority
holdouts. Restructuring regimes in industrial countries are moving toward the Chapter 11 system,
and some limited progress has been made in emerging markets, although the balance between
creditor and debtor interests varies considerably. Although there are clear advantages to a
Chapter 11–style reorganization framework, it can provide scope for delays and requires a highly
specialized judiciary. In Thailand, the process gave debtors scope for delay. Therefore, emerging
markets have to calibrate the Chapter 11 process to the realities of the specific country and build
in adequate checks and balances, such as time-bound resolutions.
Weaknesses in the bankruptcy regimes of emerging markets are detailed in chapter 6.
Gordon Johnson reports on a joint World Bank–IMF initiative to set standards for the assessment
of bankruptcy regimes (as part of a broader effort to assess financial systems). Standards were
developed for each step in the credit process, including access to credit (systems for credit
information, collateral systems, and registries), companies in financial distress (risk management
practices, resolution devices, legal frameworks for corporate workouts, and the broader
environment that would promote and enhance corporate workouts), and formal systems for
resolution and recovery. If one considers the choices made in insolvency systems along a scale,
where one extreme is pro-debtor and the other is pro-creditor, these standards fall at about the
midpoint of systems adopted in the industrial countries.
chapter 1 overview edited / corporate restructuring / p. 9
The assessments of the transition economies in Europe, several countries in Latin
America, and a few emerging markets in Asia provide a mixed picture. For creditor rights, about
half of the countries are operating more or less at a functional level, while the rest fail to meet
standards in most areas. Most systems involved in the legal frameworks for insolvency are not
working effectively, even in countries that have updated their laws in recent years. The
rehabilitation procedures for companies undergoing restructuring in emerging markets are not
much better, and the assessment of institutional and regulatory frameworks is worse. There is
enormous need for greater capacity to oversee corporate restructuring in the court systems and
regulatory bodies of emerging markets. Johnson emphasizes the weak treatment of employee
rights and social protection of labor, the lack of access to financing, and tax provisions that
penalize restructuring as major obstacles to successful corporate workouts.
In chapter 10, this broad overview of the state of bankruptcy regimes is complemented by
the perspective of a practitioner in emerging-market bankruptcy cases. Ray Davis cites the lack
of predictability in the process for recovering on defaulted debt in many emerging markets. The
lack of an effective legal framework for insolvent companies means that successful restructuring
negotiations are more dependent on intervention by government or the organization and skill of
the negotiating parties.
Davis cites several ingredients for successful restructuring outcomes. Strong leadership
by creditors is essential to impose discipline on the company and to prevent dissident creditors
from using the legal system to obstruct negotiations. Lengthy negotiations should be avoided due
to the potential for destruction of value, particularly in countries where the law enforcement
system is too weak to impose effective sanctions on destructive workers. Cash controls are
needed to protect creditors’ interests, because they prevent owners and managers from siphoning
chapter 1 overview edited / corporate restructuring / p. 10
funds from the business during negotiations. The presence of at least some local creditors can be
helpful in gaining favorable treatment by regulators and the courts, and local creditors may be
better placed than foreigners to gain acceptance of draconian measures. In Davis’s experience,
government intervention has been useful in achieving successful restructurings in Malaysia and
Mexico, but less so in Indonesia, where the Jakarta Initiative has been relatively ineffective in
larger, more complex cases.
Tax policy has an enormous impact on the success of corporate restructuring. In chapter
8, Vassilou Lampros and Gordon Johnson review case studies of how the tax system affected the
ability of firms to restructure successfully. In principle, the tax system should be neutral with
regard to operational and financial restructuring during stable economic situations and should
encourage solutions that preserve companies as ongoing concerns. During periods of systemic
corporate distress, policymakers should consider targeted promotion of rapid restructuring such
as time-bound tax incentives and amnesty of debt restructuring. In practice, tax rules are not
restructuring friendly and pose significant obstacles to financial and operational restructuring in
numerous countries. Restructuring transactions may be subject to various kinds of transfer taxes
or may trigger taxable events at a time when distressed companies lack the resources to cover tax
liabilities. Lampros covers issues such as the importance of allowing carryforward of losses to
facilitate bank mergers, steps taken to exempt corporate restructuring transactions from taxes in
Malaysia and the Philippines, tax exemptions for mutual funds set up for corporate restructuring
in Thailand, and the impact of the tax system on transactions by asset management companies in
China and Taiwan (China).
Out-of-court workout procedures, generally based on the London approach developed by the
chapter 1 overview edited / corporate restructuring / p. 11
Bank of England, have played an important role in corporate restructuring following systemic
crises. Such workouts can avoid lengthy, potentially more expensive court cases. Moreover,
following systemic crises, courts often are unable to handle the large number of restructuring
cases. Thus several countries hit by systemic crises established procedures and provided
government support for out-of-court workouts. As Stijn Claessens emphasizes in chapter 11, outof-court workouts were more successful in countries where effective bankruptcy regimes
established appropriate incentives for parties to reach agreement—for example, in Korea and
Malaysia (and, to some extent, Turkey)—than in countries with weaker legal systems—for
example, in Indonesia, Mexico, and Thailand.
Out-of-court procedures differ by country, but they typically have the following
elements: a standstill period during negotiations, designation of a lead creditor and a creditor
committee, some higher authority that can resolve cases and arbitrate disputes, reliance on
professional due diligence (audit firm or insolvency experts), agreement by majority that is
binding on all creditors, provision for rescheduling of obligations coupled with operational
restructuring, imposition of losses on both creditors and debtors, and access to new working
capital.
In chapter 12, Ira Lieberman, Mario Gobbo, William Mako, and Ruth Neyens draw
several lessons from the experience with out-of-court workouts. One key aspect is to address the
needs of different kinds of firms. The widespread failure of small businesses may be addressed
through blanket rollovers and injection of liquidity for working capital. Mid-size firms require
rollovers and extensions of bank credits to help them ride out the crisis. And the largest firms
must be dealt with on a case-by-case basis, with deep corporate restructuring and avoidance of
simple bailouts. It is important to impose losses on all stakeholders, including managers,
chapter 1 overview edited / corporate restructuring / p. 12
creditors, and owners. The authors also cite improvements to prevent and cope with future crises,
including stronger transparency to limit the problems with insider lending, greater capacity to
manage corporate restructuring, and the availability of a menu of tools to deal with crisisinduced insolvencies (including restructuring funds or special-purpose vehicles, formal
bankruptcy systems, prepackaged bankruptcies, asset management companies to provide relief to
banks, market solutions to divest asset management company assets, and voluntary workout
schemes). Finally, procedures for out-of-court workouts must recognize that coping with
systemic crises can take years and should provide for a second round of modifications once
economic conditions have stabilized.
William Mako, in chapter 7, cites lessons from the East Asian workout regimes,
beginning with those that are relatively easy to implement. The identification of the appropriate
principles and processes to guide workouts can be based on best practice examples, such as the
model memorandum of understanding for Korean workouts. Legal and regulatory impediments
to restructuring can be eliminated quickly, assuming sufficient political consensus. Governments
can and should invest in capacity to deal with future workouts and should use existing capacity
efficiently by segmenting firms by size (as in Malaysia). More difficult obstacles to successful
restructuring involve the ability of creditors to impose losses on a debtor (given weak legal
frameworks and political pressures), the government’s readiness to force creditors to recognize
losses from corporate restructuring, and the resolution of inter-creditor differences regarding the
allocation of losses and risk.
Establishing the appropriate incentives for both corporates and banks, while limiting the
economic collapse from financial crisis, is a major theme of Stijn Claessens’s paper in chapter
11. Governments are often driven to intervene to support the banking system during systemic
chapter 1 overview edited / corporate restructuring / p. 13
crises, but they should do so in ways that maintain appropriate incentives for resolving
nonperforming loans—for example, by linking the extension of government financial assistance
for recapitalization of banks directly to the pace of financial corporate restructuring undertaken
by banks. While forbearance on the imposition of prudential requirements is often necessary
during systemic crises, it should be done without condoning excessive risk taking and “cosmetic”
corporate restructuring. For example, forbearance on the capital adequacy ratio is preferable to
forbearance on provisioning for nonperforming and classified loans. While both methods of
forbearance reduce the absolute amount of capital required during periods of distress,
forbearance on the provisioning of nonperforming and classified loans masks the extent of losses
and creates adverse incentives to addressing classified loans. Similarly, forbearance should be
uniform across all financial institutions rather than on an ad hoc basis, should disclose the level
of nonperforming loans, and should have explicit time limits for expiration. Incentives for
appropriate banking and corporate behavior can also be improved by limiting ownership links
between banks and corporations, by requiring disclosure of nonperforming loans and (perhaps
phased-in) adequate loan-loss provisioning, and by amending tax, accounting, and other legal
rules to avoid discriminating against corporate restructuring. Claessens also explores the
importance of corporate governance reforms, as investment and financing behavior of the
corporate sector was often one of the major vulnerabilities that led to financial crisis.
The experience of countries in crisis indicates that a lack of expertise and experience in
managing corporate activities, political pressures, and the massive number of insolvent
corporations limited the success of banks and asset management companies in achieving
corporate turnarounds and underlined the need to dispose of assets rapidly with limited
consideration for price. Rapid asset sales can attract outside investors to the management of
chapter 1 overview edited / corporate restructuring / p. 14
operational restructuring. However, large-scale disposal of assets can be difficult because of
depressed asset prices and political pressures. One alternative is for ownership to remain with the
state for some period, but to outsource the restructuring to private sector professionals. Greater
differentiation by the type of assets is also useful—for example, between ongoing businesses and
real estate, which is relatively homogeneous and has less potential for loss of value (and can
therefore be held by asset management companies).
The conference heard the views of policymakers who had gained considerable experience
in managing the government’s response to systemic crises, as shown in chapter 13. According to
Hogen Oh, former executive chairman of Korea’s Corporate Restructuring Coordination
Committee, the government’s first step in confronting the crisis was to unify supervision of the
financial system and wrest control from the “old boys” network that had managed the
supervision of banks, insurance, and securities companies. The Financial Supervisory
Commission required banks and, by extension, corporations to adopt international accounting
standards and made the extent of losses transparent. The recognition of losses and the
elimination of cross-guarantees within corporate groups forced chaebols to restructure. The
Financial Supervisory Commission issued guidance to banks to aim for a reduction in the
leverage of the chaebols from 400 to 200 percent, a goal that was hard to achieve but did force
business leaders to take steps to rationalize their balance sheets.
The government’s approach to out-of-court workouts provided for binding decisions on
restructuring if a sufficient majority of creditors could not be reached. Workouts for some 102
corporations, including Daewoo companies, were managed, with almost all reaching a successful
conclusion. The demise of Daewoo was a watershed event that dispelled the notion of implicit
government guarantees for “too-big-to-fail” chaebols in Korea. Following Daewoo’s breakout,
chapter 1 overview edited / corporate restructuring / p. 15
other large chaebols such as Hyundai started to restructure. Oh notes that the greatest factor in
Korea’s successful corporate restructuring was that the government created an appropriate
environment and provided fiscal resources to support restructuring but, with the exception of the
Big Deals, did not meddle in the details of which industry or company would survive.
Malaysia was perhaps the most successful among the crisis countries in limiting the costs
of the crisis and spurring economic recovery. Dato’ Zainal A. Putih, chairman of Danaharta (the
Malaysian asset management company), reviews the restructuring of Malaysia’s banking and
corporate sectors. Danaharta, Danamodal (which was involved in bank recapitalization), and the
Corporate Debt Restructuring Committee (which assisted voluntary corporate restructuring)
worked in tandem to address both corporate and banking sector problems. Danaharta’s success in
speeding the disposition of nonperforming loans was assisted by special powers to facilitate the
disposition of assets, including the acquisition of nonperforming loans from banks via statutory
vesting (which sped up the transfer process), foreclosure on property collateral bypassing the
court process, and appointment of a special administrator with full control and responsibility
over a company that cannot settle its debts with Danaharta. Danamodal worked to maintain
appropriate incentives by requiring banks receiving capital injections to write down
shareholders’ capital, submit recapitalization plans, and meet monthly reporting of performance
against a list of identified targets. The Corporate Debt Restructuring Committee, or CDRC, was
established in July 1998 to help mediate voluntary out-of-court restructuring of large debt cases
involving viable borrowers with multiple major creditors. By the time CDRC closed down in
end-July 2002, it had resolved all 48 cases accepted for mediation, involving a total debt
outstanding of RM 52.5 billion.
chapter 1 overview edited / corporate restructuring / p. 16
Although the three agencies were established with the objective of maintaining financial
market stability, they worked in perfect unison, contributing directly or indirectly toward
corporate restructuring. Danaharta encouraged viable borrowers to restructure their loans,
Danamodal played a crucial role in restoring confidence in the safety and soundness of the
banking sector (thus preventing systemic failure and setting the foundation for stronger
recovery), and CDRC paved the way for operational restructuring, such as through the disposal
of assets or the sale of non-core business. Putih notes that all three agencies were created as
finite-life agencies in order to minimize moral hazard. It is notable that Malaysia’s policymakers
viewed the agencies’ role as limited to a period of systemic turbulence and elected to disband
them and rely on market discipline once the crisis had passed.
Shinjiro Takagi, chairman of the Industrial Revitalization Corporation of Japan (IRCJ),
discusses the Japanese experience with the resolution of nonperforming loans. Since 1999, Japan
has made progress in improving the bankruptcy framework and adopted guidelines for out-ofcourt workouts. Takagi notes two areas where further improvements are necessary: (a) the new
reorganization procedures treat the right of unsecured trade creditors and other unsecured
creditors equally, thus reducing incentives for the provision of trade credit, which is essential for
maintaining a business as a going concern, and (b) the guideline for out-of-court workouts
requires the consent of all affected financial creditors, so that no compulsory power exists to
induce creditors to accept the plan. Along with reform of the law, almost all the courts in Japan
are opening their gates wider to reorganization cases, and the cases are being handled more
expeditiously.
IRCJ was established to purchase loans owed by distressed debtor companies that can be
rehabilitated. Companies and staff from the company’s “main bank” submit restructuring
chapter 1 overview edited / corporate restructuring / p. 17
proposals to IRCJ, and after extensive review and revisions to the plan, the company and bank
submit a formal request for assistance. On approval, IRCJ purchases the debt when the “nonmain banks” apply for debt purchase or agree to the reorganization plan and then sells the
purchased debt within three years. Banks were reluctant to bring large, influential cases to IRCJ,
because they were concerned about losing control during the valuation process and their
financial strength deteriorated during the prolonged economic recession. However, with the
recent recovery and restored profitability, the main banks are bringing more cases this year.
[1] Restructuring Techniques [end]
Progress in corporate restructuring requires more than ensuring that regulators and private sector
agents face the appropriate incentives. The size of banks’ nonperforming loans, coupled with the
government’s commitment to support the financial sector (and indeed the government’s
responsibility for economic stability and growth), has required specific financial interventions to
resolve corporate distress. Governments that have achieved some success in corporate
restructuring have established new institutions, provided the legal basis for new forms of
transactions, and adopted innovative financial strategies to facilitate the disposal of distressed
assets.
In chapter 15, Richard Daniel reviews the prerequisites for resolving a large overhang of
nonperforming loans, based on his experience heading the Grant Street National Bank (set up to
liquidate low-quality assets from Mellon Bank). First, it is necessary to take the portfolio of bad
loans away from the lenders who made them. The initial lenders are likely to be unwilling to
acknowledge, or even recognize, their own mistakes. Moreover, collecting on bad loans, or
chapter 1 overview edited / corporate restructuring / p. 18
restructuring companies, requires a different set of skills than making new loans. The collector
needs to know when a loan is bad and how to extract the most out of the situation as fast as
possible. And the loan collector needs to have the unqualified determination to collect, which
may be difficult for loan officers who originated the bad portfolio. But more than the appropriate
personnel, banks dealing with an excessive problem loan portfolio need effective credit quality
control and asset classification, access to a well-functioning legal system to help force collection,
sufficient reserves, and the will to stop making, or renewing, bad loans. This latter quality can be
a major problem in countries trying to move from a state-managed to a free-market economy.
The establishment of centralized agencies to take over and dispose of banks’ distressed
assets was a common feature of countries hit by systemic corporate crises. After an introduction
by Ruth Neyens of the World Bank, chapter 14 gives presentations by managers in some of the
more successful asset management companies, including Dató Zukri Samat from Danaharta,
Beom Choi of the Korea Asset Management Company, and Yang Kaisheng, president of China’s
Huarong. Taking nonperforming loans off of the banks’ books enabled them to focus on the core
activities of financial intermediation, minimized the incentive for banks with dwindling (or
negative) capital to take large risks, severed the ties between banks and corporates that impeded
asset resolution, and enabled banks to clean up their balance sheets, a prerequisite for raising
further capital. Setting up new agencies with special powers also allowed governments to
eliminate some of the legal obstacles to restructuring, while maintaining control over the process.
And centralizing extremely scarce restructuring expertise in one or a few agencies helped to
achieve economies of scale in restructuring.
But not all asset management companies achieved a substantial, rapid restructuring of
nonperforming loans. The landscape is full of failed agencies, such as Mexico’s FOBAPROA
chapter 1 overview edited / corporate restructuring / p. 19
(Spanish acronym for Bank Fund to Protect Savings) and the Indonesian Bank Restructuring
Agency. The relatively successful agencies presented here are the exceptions. First and foremost,
each agency emphasized transparency as a key principle of operations, to maintain public
confidence in the process, facilitate acceptance of asset management company decisions by
ensuring fairness, and enable potential buyers to evaluate assets for sale. For example, Danaharta
took particular care to ensure transparency by requiring disclosure of business plans, public
notices, and regular reports on progress. Governance structures that ensured efficient
administration, open transactions, and checks and balances on management were equally critical
to success. Danaharta provided for the review of restructuring plans by an independent adviser
and for approval by secured creditors. And KAMCO emphasized transparent procedures and fair
transactions. Each company had only one opportunity to restructure, which minimized strategies
that maintained company operations while delaying resolution of the underlying problem.
Malaysia also mandated that Danaharta be short-lived, so that the agency could not perpetuate
itself and banks would realize that they, not the government, were responsible for future
nonperforming loans.
The asset management companies also benefited from special powers that were not
available to other institutions, principally the banks. The act establishing Danaharta facilitated
the acquisition and disposal of assets—for example, by enabling Danaharta to foreclose on
collateral and bypass court auction processes. In China, the asset management companies have a
critical advantage over the state-owned commercial banks, as the banks cannot grant debt
forgiveness, while the asset management companies are allowed to resolve assets at less than
their book value. Some of the innovative financial structures established by KAMCO to dispose
of distressed assets benefited from tax incentives.
chapter 1 overview edited / corporate restructuring / p. 20
Engaging private sector cooperation and ensuring competitive markets were critical.
Successful asset management companies adopted a menu of asset disposition strategies, so that
flexibility and the ability to innovate were important to progress:
[begin list]

In Malaysia, the asset disposition process was market driven, with competitive bidding
through a transparent process and, to the extent possible, enhancement of the value of
business or collateral. Danaharta took over approximately 3,000 accounts with a value
(determined by professional appraisers) of RM 52 billion and is expected to recover 58
percent.

China’s Huarong uses various resolution strategies, including agreement on revised
repayment plans, discounted borrower payoffs, debt-to-equity swaps, collateral sales,
litigation, and the sale of nonperforming loan assets to third-party investors. Over the past
four years, Huarong has resolved more than $16.6 billion in nonperforming loans, with an
average asset recovery rate of 32 percent.

KAMCO employs a range of financial techniques, including portfolio sales,
securitization, public sales, foreclosure sales, individual loan sales, and rescheduling. One
innovative aspect of KAMCO’s operations is the use of a variety of financial structures to
encourage private equity participation, including joint ventures, corporate restructuring
companies that managed a wide variety of companies undergoing restructuring, asset
management companies established under the Asset Securitization Law, and corporate
restructuring vehicles that focused on restructuring single companies.
[end]
chapter 1 overview edited / corporate restructuring / p. 21
Two innovative approaches to asset disposition are worthy of further comment. In order
to increase the speed of asset resolution, Huarong sold portfolios of nonperforming loans, in part
to foreign investors. This involved resolving a host of regulatory and policy issues concerning
the participation of foreign investors. The first international auction was held in 2001, and the
second in 2003, with a nonperforming loan portfolio totaling $3 billion. Huarong also piloted a
quasi–nonperforming loan securitization program, under which assets with relatively high future
cash flows are transferred through a trust to private investors, similar to a securitization deal
(legal, accounting, and supervisory obstacles prevent a true securitization deal in China).
KAMCO’s corporate restructuring vehicle is a financial structure that focuses on
restructuring viable companies of medium or large size. The corporate restructuring vehicle also
enjoys tax benefits, which helped banks to dispose of equities received in debt-equity swaps.
Despite its promise, only a few transactions have occurred. The new legal structure and the
valuation of large companies are complicated, and, without the threat of court-imposed losses,
corporate debtors lack incentives to agree to draconian restructuring measures required in
transferring a corporation to a corporate restructuring vehicle. Some creditors also balk at the
transfer to a corporate restructuring vehicle: underprovisioned banks are unwilling to give up
control over their larger properties (which could mean having to recognize large losses), senior
creditors are reluctant to be treated equally with other rights holders, and loan guarantors are
unwilling to recognize losses immediately. Thus holdout creditors often request a cash exit,
undermining the ability to use the structure of a corporate restructuring vehicle.
Christopher Vale provides a manager’s perspective on the Korean corporate restructuring
funds in chapter 16. Corporate restructuring funds were established with the dual objectives of
improving performance and achieving policy goals—for example, support for the small and
chapter 1 overview edited / corporate restructuring / p. 22
medium enterprise sector devastated by the crisis, encouragement of new investments and
technological development, and achievement of stronger corporate governance. The multiple
mandates at times led to difficult tradeoffs. For example, there was little international appetite for
funds with policy objectives, so funding had to be mobilized from domestic banks. The funds
could only invest in newly issued debt or equity, which hindered some transactions (for example,
a fund could not buy old debt at a distressed price). The funds were subject to guidance from the
Ministry of Finance (for example, when they were asked to get involved in restructuring in
addition to making new investments), although the government did not interfere in individual
investment decisions. The funds were limited to 50 percent in the equity of the chaebol and 10
percent in any one company and were required to make at least 25 investments. Given the
relatively small size of the funds ($250 million), the largest investment was $25 million and the
average was $10 million. This was difficult to achieve with any reasonable administrative cost.
The fee structure was poorly designed and generated inadequate profits. And the management
contract was for two years, which was insufficient to allow investments to mature.
The investment funds had some positive impact on the Korean economy. Many small and
medium enterprises were provided equity financing, and merchant banks were motivated to get
involved in the restructuring process. Interest by the foreign-managed funds increased the
interest of other investors in targeted companies. Improvements in the structure of the funds for
the future could include setting up funds offshore to avoid some constraints of the mutual fund
law in Korea, avoiding annual distributions that limited flexibility and exposed the fund to tax
liability, achieving better support from an active board (the boards of the funds were composed
largely of banks that had been forced to contribute and were concerned mostly with getting their
money out rather than with improving operations), and limiting the range of investments.
chapter 1 overview edited / corporate restructuring / p. 23
The development of distressed debt markets would assist banks and governments in
finding market solutions to dealing with bankrupt corporations. However, as John Butler Jr., Bill
Derrough, and Lynn Hiestand describe in chapter 17, the secondary markets for distressed
corporate debt are relatively underdeveloped in most emerging markets. While progress has been
made in creating markets for distressed debt in some countries of Asia and Latin America, little
has been done in Africa and the Middle East. Efforts to sell distressed debt are subject to lengthy
due diligence and lack of standard documentation, leading to variable and sometimes protracted
settlement periods, creating the potential for failed trades and substantial legal costs. In order to
build effective markets for distressed debt, countries need a high level of transparency and
reasonable certainty of how the laws dealing with troubled situations will be enforced. Measures
to increase the transparency and efficiency of distressed debt markets include standardization and
simplification of loan agreements, standards for settlement procedures, codes of practice for
market activity (such as a protocol for due diligence), and transparent mechanisms for loan
valuation. Butler, Derrough, and Hiestand cite efforts by the Asia Pacific Loan Market
Association to develop a secondary market in corporate debt in Asia.
[1] Reference [end]
Kaminsky, Graciela, Saul Lizondo, and Carmen Reinhart. 1997. ”Leading Indicators of Currency
Crises.” Policy Research Working Paper 1852. World Bank, Latin America and
Caribbean, Office of the Chief Economist. Washington, D.C.