Abstract
The paper investigates the complementary role of hard and soft information in affecting the bankruptcy outcome of in-court procedures. Previous literature mostly focuses on hard information as driver of the bankruptcy outcome. In a bankruptcy context, we identify the causes of default as a key piece of soft information which can emerge through a textual analysis of the legal papers written by the insolvency practitioners. We posit that soft information complements hard information in guiding creditors’ choice of the bankruptcy outcome. To test our hypotheses, we construct a unique dataset composed of hard and soft information of Italian Small and Medium Enterprises that faced in-court debt renegotiation between 2011 and 2016. We show that the role of hard information in guiding creditors’ decisions depends on the specific cause of default they interact with and we conclude that the two sets of information jointly shape the conditions for the bankruptcy outcome.
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Notes
Text files can obviously be translated into numbers. However, how much valuable information is lost in the process remains a big issue. This process is named as “the hardening of information” (see Liberti and Petersen 2018).
Liberti and Petersen, describing the features of the soft information collection process, precise: “prior to collecting the information, we are unsure what we might find or why it may be valuable until after we collect the data. Think of this knowledge as arising out of training and experience (Berger and Udell 2006). Later, when we are confronted with a decision, we recall the information collection process (e.g., the experience), and it is only then that is it apparent how the information we collected is useful. This is another characteristic of soft information.” (Liberti and Petersen 2018: 4).
Out-of-court the access by all the creditors to information on the true causes of default may be limited, as no official audit by insolvency practitioners is prescribed.
According to the art 177 of the Bankruptcy Law “creditors with privilege, pledge, or mortgage, even if the guarantee is disputed, for whom the proposal for a composition provides for full payment, have no right to vote unless they renounce their preferential right in whole or in part. If creditors with privilege, pledge, or mortgage renounce in whole or in part their preferential right, for the part of the debt not covered by the guarantee, they are equated with unsecured creditors; the waiver has effect only for the purposes of the composition. Creditors with preferential rights for whom the proposal for a composition provides, in accordance with Article 160, for partial satisfaction, are equated with unsecured creditors for the remaining portion of the debt”.
The Veneto Region is one of the twenty Italian Regions, on the North-East side. The industrial strength of Italy is displaced in the Northern part of the country, which in 2016 accounted for the 55.9% of the national GDP (22.6% was produced in the South and 21.5% in the Centre). The Veneto Region contributes 16.6% of the Northern production, being the third largest region in terms of GDP at the national level (9.3% of Italian GDP in 2016) [Data are from I.Stat Database, the online portal of I.Stat, the Italian National Institute of Statistics, publicly available at: dati.istat.it/Index.aspx (Access date: 10/09/2018)].
The detailed description of the adopted coding procedure is presented in Sect. 3.3.
Whereas other types of SI (as managerial ability of the firm’s managers, mutual trust between the firm and the bank’s loan officers) are excluded by the insolvency practitioner’s audit and thus less available to the entire creditors’ community, as such assuming a less relevant role in guiding their assessment over the business’ viability.
Other types of information may be classified SI as well: the managerial ability of the firm’s managers, the mutual trust between the firm and its stakeholders, for instance.
One of the advantages of in-court procedures respect out-of-court agreements concerns the higher availability of information produced.
In making this assertion, we are implicitly excluding those bankruptcy legislations where the decision over the debt restructuring plan belongs to the court and not to the creditors (as for the French case, for instance). Courts’ deliberative process may differ from the one that creditors undergo. As we will discuss in the concluding section, this represents a limitation of our work, which focuses on those contexts where the decisional power is reserved to creditors. Future works may investigate the role of SI in guiding debt renegotiations in those legislations where the decisional power does not belong to creditors.
Italian Legislative Decree 27th June 2015, number 83 introduces a minimum debt recovery rate of 20% that the restructuring plan must grant to unsecured creditors in case of liquidation (as hereinafter described, debt restructuring plans can provide also for a liquidation outcome). The firm unable to meet this requirement is redirected toward the full liquidation procedure. After the 2005 reform and till 2015 no minimum recovery rate was required. Yet, the low recovery rate often granted to unsecured creditors (sometimes even inferior to 5%), with the in-court procedure often used for liquidation purposes, led the legislator to introduce this requirement.
Some creditors may be already aware of the causes of default considering the long-lasting relational ties often linking SMEs to their creditors (as argued by Moro and Fink 2013). Others may learn them directly from the legal documents. This does not affect our theory, as the creditors’ awareness of the causes of default is formed anyway before their decision over the plan, and SI on the causes of default becomes in any case functional at their voting choice. Moreover, the fact that some creditors may know in advance the causes of default guarantees that the causes of default are reported fairly in the legal documents to avoid contestations, increasing the reliability of the information that these papers contain.
The full liquidation procedure (Art. 1 and seqq. Italian I.L.) is usually longer in time and less favourable for creditors in terms of recovery rates (Danovi et al. 2018). The substantial difference between a restructuring plan with a liquidation aim and the full liquidation procedure is that while the former is a contractual solution between firm and creditors, where debtor controls the firm throughout the process, in the latter one a piecemeal liquidation coordinated by a trustee appointed by the court is enacted.
Full dispossession is provided also under Extraordinary Administration (Amministrazione straordinaria delle grandi imprese in crisi), which rules restructuring of larger enterprises following Italian Law number 347/2003. This procedure maintains a hybrid nature (it may be adopted either for going concern or liquidation purposes); under its provisions the enterprise is administered by one or more commissioners appointed by the Minister of Economic Development. The focus on larger enterprises and the formal involvement of the State provided under this procedure render it outside the scope of our research.
Venice, Padua, Verona, Vicenza, Treviso, Rovigo and Belluno.
The Italian Ministry of Justice reports 18,731 PACs and 1,646 TDRs opened at the national level between 2011 and 2016, showing a proportion among the two instruments similar to the one we find. Danovi et al. (2018) attest that, in the period 2010–2016, approximately the 56% of Italian in-court procedures were opened in Northern Italy’s courts.
The two firms are part of the restructuring of a whole industrial group, for which data of societies involved in the rescue are missing.
Following European Commission Recommendation 2003/361/EC, a firm is considered:
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Micro when it presents less than 10 employees and, alternatively, turnover equal or inferior to 2 m € or balance sheet total equal or inferior to 2 m €;
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Small when it presents less than 50 employees and, alternatively, turnover equal or inferior to 10 m € or balance sheet total equal or inferior to 10 m €;
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Medium when it presents less than 250 employees and, alternatively, turnover equal or inferior to 50 m € or balance sheet total equal or inferior to 43 m €.
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We consider the date of the firm’s petition to the Court for admission to the procedure.
We prefer the classification proposed by Blazy et al. (2011, 2013) respect the one of Collett et al. (2014) as the first, as for our case, relies on the causes of default as reported in bankruptcy documents for SMEs that faced the in-court procedure. Differently, the second is obtained from a review of the literature on turnaround and then perfectioned through questionnaires to court-appointed administrators. The classification of Blazy et al. (2011, 2013) results thus much more suitable for our research question.
Tinsley and Weiss (2000) define intercoder agreement as “the extent to which the different judges tend to assign exactly the same rating to each object” (p. 98). Sandelowski (1995) reports as a strong intercoder agreement suggests that the coded concept is not a mere figment of the coder’s imagination, increasing the chances that the theme is valid. We compute intercoder agreement measurement as the ratio between the number of matching coding cases over the number of total coding cases. See Fleiss et al. (2003) for an in-depth discussion on intercoder agreement measurements.
Financial and accounting figures of the same year of bankruptcy triggering can be affected by operations related to the unfolding of the proceeding, making thus figures of the year before bankruptcy triggering more reliable to account for the financial/economic conditions of the firm at bankruptcy triggering.
See Sect. 2.2 for details on criteria used to include or not a cause of default from our framework.
We add 1 to avoid Ln(0) when no items are reported within the cause. Thus, for instance, if a firm reported that suffered from “Increasing costs of raw material” and from “High fixed costs”, then the Production cause, that includes these two items, for this firm is defined as Ln(1 + 2) = Ln(3).
Bankruptcy literature (for example Blazy et al. 2014; Chatterjee et al. 1996; Brown et al. 1994) indicates that the size of the firm, the duration of its liabilities and the proportion of bank debt affect the debt renegotiation process, yet it does not provide a sound rationale of a synergic effect of such HI factors with SI on the causes of default that may affect the decisions of creditors. As such, we control in the model for these HI factors yet without interacting them with the causes of default.
IIA requires that if an alternative x is preferred to the alternative y within the choice set {x, y} (that is liquidation vs. reorganization, in our context), introducing a third option z (that is acquisition), so expanding the choice set to {x, y, z}, must not make y preferable to x. IIA is one of the conditions of Arrow’s impossibility theorem (see Arrow 1963).
For the identification of the economic sectors the firms of our dataset belong to, we refer to the ATECO classification, the classification of economic activities adopted by the Italian National Institute of Statistics (ISTAT).
If some operative units of the firm are acquired and some dismantled/liquidated piecemeal, according to the approach undertaken by the Italian jurisprudence, we qualify the case as liquidation when the liquidated part exceeds the acquired one. We base our conclusions onto the economic content of the debt renegotiation plans and thanks to the help of a judicial commissioner that supported us for the classification of more complicate cases. It is worth mentioning that Italian jurisprudence only distinguishes between liquidation and continuation, disciplined under different articles of the Insolvency Law. Till 2015 there has been a discussion within the Italian jurisprudence regarding the classification of the different cases under the continuation or the liquidation framework. This derives by the two different points of view that may be adopted. In fact, where part of the jurisprudence adopted the point of view of the economic entity (the firm), a second line of thought adopted the point of view of the incumbent entrepreneur/ownership. Embracing this second perspective, any form in which there is a dispossession of the assets (even so if the entire viable firm is sold to a third subject) may constitute liquidation. Since 2015 the jurisprudence has aligned to the point of view of the economic entity; as such forms of “indirect continuation” (continuità indiretta, that is acquisition) still constitute continuation. We align to this prevalent view, even for cases before 2015, again basing our conclusions onto the economic content of the plans and thanks to the mentioned support of an experienced judicial commissioner.
We report descriptive statistics referring to the number of observations actually available for each HI factor.
For descriptive statistics, a cause is counted whenever a company reports at list one item contained in the cause. If more items for the same cause appear, the cause is still counted once (data on single items can be provided by the authors upon request). The value in parentheses represents the percentage of cases in which the cause appears within the total of the cases; the sums exceed 100% as a company may suffer from more causes of default.
These values are defined considering the firms in the dataset altogether, thus do not appear in Table 5 that divides the firms by bankruptcy outcome and by size.
Econometrical analysis is performed over the 195 observations for which we have complete data for all the HI factors included in the model. We have 13 cases with at least one HI missing value which are thus automatically excluded from the regressions.
Art. 1 of the French Insolvency Law (Law number 85–98 of 25 January 1985) defined the priorities of the bankruptcy process, ranking first the continuation of the business, second the safeguard of employment and third the repayment of liabilities.
We do not report the results of the test because of space limit. They are available upon request.
We do not report all the robustness tables because of space limit. They are available upon request.
Specifically, we processed the Heckman model running the following combinations for the variable Bankruptcy outcomei:
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it assumes value 1 when business’ continuation occurs at the end of the bankruptcy process, either through business’ acquisition or reorganization, and 0 if piecemeal liquidation occurs;
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it assumes value 1 if business’ acquisition occurs and 0 if piecemeal liquidation does;
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it assumes value 1 if business’ reorganization occurs and 0 if piecemeal liquidation does;
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it assumes value 1 if business’ reorganization occurs and 0 if business’ acquisition does.
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Acknowledgements
We thank professors Régis Blazy, Giovanni Ramello and Nadine Levratto for their helpful comments and useful suggestions. We also thank the Venice Chamber of Commerce & Industry and Roberto Crosta, General Secretary of the Padova Chamber of Commerce & Industry and of Unioncamere del Veneto for support in providing access to the needed documentation.
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Cocco, L.M., Cavezzali, E., Rigoni, U. et al. How does soft information on the causes of default affect debt renegotiation? The Italian evidence. Ann Finance (2024). https://doi.org/10.1007/s10436-023-00435-0
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DOI: https://doi.org/10.1007/s10436-023-00435-0