Ebook Multiple lenders and corporate distress: Evidence on debt restructuring
In 2001 during the aftermath of the sudden collapse of Swissair, at the time one of Europe’s most prestigious airlines, Oliver Hart noted that the company could probably have been saved had there been coordinated action in the Swiss financial market among all lenders involved prior to the initiation of formal bankruptcy proceedings (see Hart (2001)).
Drawing on private information collected from major German banks, this paper analyzes a financial institution, the bank pool (’Bankenpool’), which is able to eliminate the risk of uncoordinated creditor action when corporate distress is imminent. We find bank pools to be a commonly used coordination device within the German financial system. Despite its importance for financial contracting and for the economics of relationship lending in distress, bank pools have rarely been taken into account by outside observers and academics. To the best of our knowledge, this is the first analysis of the pool institution, and its role in corporate distress.
Our data set comprises medium-sized, privately held non-financial companies in Germany, sampled from the credit files of the largest commercial banks. Most companies in the sample (91 out of 95) have multiple bank relationships, with a median of 5, and a maximum of 17 banks. Multiple banking is common in many countries around the world. For large public companies from 22 countries, Ongena and Smith (2000) find the average number of bank relationships to vary from 2.9 in Norway to 15.2 in Italy. They attribute the cross-country differences to the concentration of the banking system and to the strength of creditor rights. Weaker concentration in the local banking market and stronger creditor rights tend to go hand in hand with more bank relationships.
Rajan (1992) states multiple banking may well be beneficial in normal times because it eliminates the hold-up risk inherent in single-source bank financing. Multiple banking also protects the debtor against a sudden deterioration of the liquidity position of the bank, as argued by Detragiache et al. (2000). However, if the borrower himself is in distress, multiple banking is likely to be a disadvantage. In such a situation coordination between creditors is required, but may be difficult to achieve. There is a large body of literature that focuses on the difficulties experienced by multiple lenders attempting to coordinate their actions. For example, Gertner and Scharfstein (1991) analyze the free-rider problem in corporate distress, and Morris and Shin (2004) emphasize the associated welfare loss of a creditor run.
We find no evidence of creditor runs before or during the distress episodes experienced by the companies in our sample. Loan terminations typically occur after a prolonged distress episode only. However, we observe an extensive involvement of banks in debt restructuring and workout activities. The involvement in distress episodes covers, among other things, the allocation of fresh money to the troubled borrower, the hiring of experts to provide management consultancy and, in some cases, the pressing for management dismissal.
The active involvement of the banks is often, but not always, accompanied by explicit coordination among the lenders. In 46% of all cases in our sample, the group of bank lenders concludes a formal contractual agreement that effectively aligns investment incentives. This agreement is called a pool arrangement. The pool is set up around the onset of a distress episode, and it will be disbanded when the company has been successfully worked out, has been sold, or when it is liquidated. The rules and regulations governing the life of the pool are a result of private contracting. The pool institution, together with its internal decision rules, is an arrangement that is strictly based on incentive compatibility and reputation effects.
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