Mergers, Acquisitions, and Corporate Restructurings

The 1990–91 recession, combined with the unraveling of many of the leveraged transactions of the fourth merger wave, called attention to the creative corporate finance uses of bankruptcy. Reorganization through the bankruptcy process is a tool of corporate finance that in certain instances provides unique benefits that are unattainable through other means. This chapter explores the different forms of bankruptcy and discusses the circumstances in which a company would use either of the two broad forms of corporate bankruptcy that are available: Chapter 7 and Chapter 11. Chapter 7, liquidation, is appropriate for more severely distressed companies. Chapter 11, reorganization, however, is the more flexible corporate finance tool that allows the company to continue to operate while it explores other forms of restructuring. In addition, Chapter 11 allows companies to continue to operate while a reorganization plan is being developed and approved.

Clearly, bankruptcy is a drastic step that is only pursued when other more favorable options are unavailable. A bankruptcy filing is an admission that a company has in some way failed to achieve certain goals. The term business failure is somewhat ambiguous and has different meanings, depending on the context and the users. There are two main forms of business failure: economic failure and financial failure. Each has a very different meaning.

Of the two broad types of business failure, economic failure is the more ambiguous. For example, economic failure could mean that the firm is generating losses; that is, revenues are less than costs. However, depending on the users and the context, economic failure could also mean that the rate of return on investment is less than the cost of capital. It could also mean that the actual returns earned by a firm are less than those that were forecast. These uses of the term are very different and cover situations in which a company could be unprofitable as well as cases in which the company is profitable but not as profitable as was expected.

Financial failure is less ambiguous than economic failure. Financial failure means that a company cannot meet its current obligations as they come due. The company does not

-432-