Document Type

Correspondence

Publication Date

2008

Abstract

In Bankruptcy Fire Sales, Professor LoPucki and Dr. Doherty do two things. First, they present provocative data about the relative payoff to be had in Chapter 11 by a full reorganization compared with the payoff from a section 363 sale without a full reorganization. Second, they give a yet more provocative explanation for their data. Taking a page from Professor LoPucki's recent book, they blame the meager return that they observe on 363 sales on the unprincipled behavior of the lawyers, managers, creditors, investment bankers, and even judges involved in the sales. Messrs. LoPucki and Doherty's data appear to show that firms that leave Chapter 11 through the side door-that is, via section 363 sales-bring far less for their creditors than they would bring if they had left via the front door as reorganized companies: [C]ompanies sold for an average of 35% of book value but reorganized for an average fresh-start value of 80% of book value and an average market capitalization value-based on post-reorganizations stock trading-of 91% of book value. Even controlling for the differences in the prefiling earnings of the two sets of companies, sale yielded less than half as much value as reorganization.1 So if you leave bankruptcy through the side door, you reap 35% of book value, but if you leave through the front door, you get as much as 91%.2 These are astounding numbers. If they are accurate, why would anyone, a creditor, a judge, or even the debtor or the debtor's lawyer, choose a 363 sale over reorganization? Professor LoPucki finds that most of the actors on the bankruptcy stage have malign motives-to bring more cases to their courts (the judges), to earn payments from third parties who buy their companies (the managers), or to ingratiate themselves with future clients (the investment bankers). It goes without saying that Messrs. LoPucki and Doherty doubt the auction market's ability to produce fair value. Messrs. LoPucki and Doherty's article grandly avoids the traditional empiricists' nightmare, the null hypothesis. Academic papers that have failed because the data collected neither prove nor disprove the hypothesis are common. The problem for Messrs. LoPucki and Doherty is the opposite; their data are so powerful that many will find them impossible to believe. If a typical company that is worth $91 million in reorganization is truly worth only $35 million in a 363 sale, either the auction market must be grossly inefficient or-contrary to all belief-the reorganization process is so efficient that it enhances the value of the companies reorganized. In this paper I raise two other possibilities. First, I believe that Messrs. LoPucki and Doherty's enterprise numbers overstate the value that goes to the reorganized companies' creditors. Second, I believe there is a selection error in the samples of Messrs. LoPucki and Doherty. Although the cases where reorganization occurred look much like the cases where there was a 363 sale, I believe that they are systematically different and that that difference explains a part of the apparent difference in payoff to creditors. Note, too, that while a casual reader of the quote above might conclude that the entire difference between 80% (or 91%) payoff and 35% payoff is attributable solely to the choice of a 363 sale or a full reorganization, that is not the real claim of Messrs. LoPucki and Doherty. Table 1 and the discussion that follows on page 24 of their article show that the authors claim only that about 30% of the variance in the recovery ratios can be explained by the choice of sale versus reorganization.' Careful examination of Table 1 will reveal what most suspect, namely that at least some significant part of the difference is explained by the earnings and earning potential of the companies. Messrs. LoPucki and Doherty put the influence of earnings before interest, taxes, depreciation and amortization ("EBITDA") at around 13%.

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