Preface

In looking back over the first three editions of Corporate Financial Distress and Bankruptcy (1983, 1993, 2006), we note that with each publication, the incidence and importance of corporate bankruptcy in the United States had risen to ever more prominence. The number of professionals dealing with the uniqueness of corporate death in this country was increasing so much that it could have perhaps been called a "bankruptcy industry." There is absolutely no question in 2019 that we can now call it an industry. The field has become even more significant in the past 15 years, accompanied by an increase of academics specializing in the area of corporate financial distress. Indeed, there is nothing more important in attracting rigorous and thoughtful research than data! With this increased theoretical and especially empirical interest, Wei Wang, has joined the original author (Altman) of the first three editions and Edith Hotchkiss (from the third edition) to produce this volume.

It is now quite obvious that the bankruptcy business is big-business. While no one has done an extensive analysis of the number of people who deal with corporate distress on a regular basis, we would venture a guess that it is at least 45,000 globally, with the vast majority in the United States but a growing number abroad. We include turnaround managers (mostly consultants); bankruptcy and restructuring lawyers; bankruptcy judges and other court personnel; accountants, bankers, and other financial advisers who specialize in working with distressed debtors; distressed debt investors, sometimes referred to as "vultures"; and, of course, researchers. Indeed, the prestigious Turnaround Management Association (www.tumaround.org) total members numbered more than 9,000 in 2018.

The reason for the large number of professionals working with organizations in various stages of financial distress is the increasing number of large and complex bankruptcy cases. Despite the fact that the United States has been in a benign credit cycle since 2010, during the six-year period of 2012-2018, 130 companies with liabilities greater than $1 billion filed for protection under Chapter 11 of the Bankruptcy Code. Over the past 47 years (1971-2018), there have been at least 450 of these large, mega-bankruptcies in the United States. Just before finishing our first draft of this book, one of the nation's largest retailers, Sears, Roebuck and Company, filed for Chapter 11 with over $11 billion of liabilities! And the number of mega-bankruptcies, as well as the total of all filings, will spike dramatically when the next financial crisis hits, especially due to the enormous build-up of corporate debt in recent years.

This book is a completely updated volume that includes updated key statistics and surveys the most recent academic studies. Newly added chapters include those on leveraged finance, out-of-court restructurings, and international insolvency codes, as well as a review of the Altman Z-Score family of models and their applications to celebrate the 50th birthday of the original Z-Score model. The 16 chapters in this new edition cover the most important aspects of leveraged finance, high-yield markets, corporate restructuring, bankruptcy, and credit risk modeling.

Starting with Chapter 1, we define corporate distress and present the statistical background for corporate defaults and bankruptcies over the past few decades. The chapter also discusses the common reasons for corporate failures and presents the organization theory that guides practice. In addition, the chapter introduces the key industry players in distressed restructuring and investing.

The leveraged finance market experienced an unprecedented boom in the past two decades, the total issuance of leveraged loans and high yield bonds reaching close to $1 trillion in 2017. The markets have been quite creative at producing new financial instruments (e.g. second-lien, covenant-lite) as the markets have grown. These instruments are attractive to not only traditional commercial lenders but also alternative investors due to their high yield and high fee structure. Chapter 2 provides an overview of the two major categories of debt instruments in this space and discusses typical features of these instruments, lender protections, default and remedies, as well as debt subordination issues. This material is particularly necessary to understanding the priority of debt claims and their relative bargaining position in distressed restructuring.

Chapter 3 provides an overview of the U.S. bankruptcy system. We begin by briefly illustrating the evolution of the U.S. bankruptcy law since the equity receiverships of 1898. We provide a primer on Chapter 11 by introducing the key provisions of the U.S. Bankruptcy Code after the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA). Our summary and interpretation of important sections of the Code is written to be accessible to students and practitioners in finance as well as a legal audience. We review the many relevant academic studies, and also provide examples from recent cases to help readers gain an in-depth understanding of the bankruptcy process. The conclusion to this chapter summarizes the ABI Commission Report of 2014 advocating revisions to the existing code.

Firms suffer large costs of financial distress, and bankruptcy restructuring can be even costlier. These costs include not only direct costs such as out-of-pocket expenses for lawyers and finance professionals, but also a wide range of opportunity costs known as indirect costs. Firms generally have strong incentives to avoid these costs by conducting private negotiations and restructuring out-of-court. When and how can firms successfully restructuring out of court? Why do others restructure in court? Chapter 4 attempts to answer these questions.

Chapter 5 explores the analytics and process for distressed firm valuation. We provide a careful discussion of valuation models, and consider why we observe wide disagreements over firm value between different stakeholders in the negotiation process. We describe in depth best practices in valuation methods, using the example of Cumulus Media which filed for Chapter 11 in November 2017.

Virtually every aspect of a firm's governance can change in some way when a firm becomes financially distressed. Management turnover increases, board size declines, and boards often change in their entirety at reorganization. A substantial number of restructurings lead to a change in control of the company. Chapter 6 discusses key corporate governance issues for distressed firms, including fiduciary duties of managers and boards, complexities in providing compensation, and the value of creditor control rights. We wrap up the chapter by discussing managerial labor markets and labor issues.

In Chapter 7, we explore the success of the bankruptcy reorganization process, especially with respect to the postbankruptcy performance of firms emerging from Chapter 11. In numerous instances, emerging firms suffer from continued operating and financial problems, sometimes resulting in a second filing, unofficially called a Chapter 22. Indeed, we are aware of at least 290 of these two-time filers over the period 1984-2017 (see Chapter 1), and 18 three-time filers (Chapter 33s). There are even three Chapter 44s and at least one Chapter 55! Despite the numbers of bankruptcy repeaters, there are also some spectacular success stories upon emergence from bankruptcy, at least from the perspective of equity holders in the reorganized company.

Chapter 8 provides a brief summary on international insolvency regimes, paying particular attention to countries including France, Germany, Japan, Sweden, UK, China, and India. We focus on these representative countries because of the distinct nature in their legal procedures, significant growth in their restructuring industry in recent years, and the availability of related empirical academic research. Our brief discussions for these countries highlight the most important features of their legal systems for restructuring as well as ongoing issues and reforms.

The second part of the book provides comprehensive coverage of high yield bond markets, default prediction models and their applications, and distressed investing. We explore in depth the estimation of default probabilities for issuers in the United States (Chapter 10) and for sovereign issuers (Chapter 13) and the loss given default or recovery rates (Chapter 16). Chapters 11 and 12 demonstrate applications of these models for many different scenarios, including credit risk management, distressed debt investing, turnaround management and other advisory capacities, and legal issues. Chapters 14 and 15 go on to examine the size and development of the distressed and defaulted debt market.

Chapter 9 explores risk-return aspects of the U.S. high-yield bond and bank loan markets, most important to highly levered and distressed firms. Since high-yield or "junk" bonds are the raw material for future possible distress situations, it is important to investigate their properties. Among the most relevant statistics to investors in this market are default rates, as well as recovery rates for firms that default. The U.S. high-yield corporate bond market reached more than $1.6 trillion outstanding in 2017, a 60% increase since the year of...