Corporate restructuring lession from experience by michael promerleano


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Corporate restructuring lession from experience by michael promerleano

  1. 1. Edited byMichael Pomerleano William Shaw
  2. 2. Corporate RestructuringLessons from Experience
  3. 3. Corporate RestructuringLessons from ExperienceEdited byMichael PomerleanoWilliam Shaw
  4. 4. Copyright © 2005 The International Bank for Reconstructionand Development / The World Bank1818 H Street, N.W.Washington, D.C. 20433, USAAll rights reservedManufactured in the United States of AmericaFirst printing March 2005 The findings, interpretations, and conclusions expressed in this book are entirely those ofthe authors and should not be attributed in any manner to the World Bank, to its affiliatedorganizations, or to members of its Board of Executive Directors or the countries they repre-sent. The World Bank does not guarantee the accuracy of the data included in this publica-tion and accepts no responsibility for any consequence of their use. The boundaries, colors,denominations, and other information shown on any map in this volume do not imply onthe part of the World Bank Group any judgment on the legal status of any territory or theendorsement or acceptance of such boundaries. The material in this publication is copyrighted. The World Bank encourages dissemi-nation of its work and will normally grant permission to reproduce portions of the workpromptly. Permission to photocopy items for internal or personal use, for the internal or personaluse of specific clients, or for educational classroom use is granted by the World Bank, pro-vided that the appropriate fee is paid directly to the Copyright Clearance Center, Inc., 222Rosewood Drive, Danvers, MA 01923, USA; telephone 978-750-8400, fax 978-750-4470.Please contact the Copyright Clearance Center before photocopying items. For permission to reprint individual articles or chapters, please fax a request withcomplete information to the Republication Department, Copyright Clearance Center, fax978-750-4470. All other queries on rights and licenses should be addressed to the Office of the Publisher,World Bank, at the address above or faxed to 202-522-2422.Library of Congress Cataloging-in-Publication Data has been applied for.ISBN 0-8213-5928-2 978-8-213-59282-6Cover Design: James E. Quigley, World Bank Institute.Photo Credit: Malcolm Fife, Photodisc.
  5. 5. ContentsPreface xixAcknowledgments xxiContributors xxiiiIntroduction: Toward Better Practices in SystemicCorporate Restructuring xxxi Michael Pomerleano The Government’s Role xxxii Monitoring xxxii Intervention xxxiv Legal Framework for Corporate Restructuring xxxvii Tax Issues xxxix Skills and Capacity xl Financial Engineering:Financial and Operational Restructuring xliii Asset Management Companies xliii Alternatives to Asset Management Companies xliv Use of Financial Techniques xlv References xlviii Notes xlix v
  6. 6. Corporate Restructuring: Lessons from Experience Chapter 1 Synopsis of Conference Papers 1 William Shaw Overviews of the Crisis and General Principles 2 War Stories from the Crises 5 Technical Issues 6 Note 7 Part I: Overviews of the Crisis Experience Chapter 2 Policy Approaches to Corporate Restructuring around the World: What Worked, What Failed? 11 Stijn Claessens Overview of Approaches 11 Government-Sponsored Voluntary Workout Schemes 14 Court-Supervised Restructuring and Bankruptcy 19 Restructuring by Public Asset Management Companies and State-Owned Banks 24 Voluntary Workouts outside Government-Sponsored and In-Court Frameworks 32 Supporting Policy Changes 35 Outcomes in Corporate Restructuring 41 Nonperforming Loans and Financial Indicators 41 Operational Restructuring Measures 48 Policy Lessons 50 An Efficient Insolvency System 51 Adequate Loss-Absorption Capacity 52 A Proper Framework of Incentives 52 A Limited Role for Banks and the State 53 A Menu of Approaches 54 Corporate Governance and Other Reforms 55 References 56 Notes 57vi
  7. 7. ContentsChapter 3Recent International Experiences in the Use of VoluntaryWorkouts under Distressed Conditions 59 Ira Lieberman, Mario Gobbo, William P. Mako, and Ruth L. Neyens The London Approach 61 Corporate Restructuring in Korea 65 Initial Government Response 66 Policy Measures 67 Workout Program 69 Daewoo: “Too Big to Fail?” 74 Special-Purpose Vehicles, Restructuring Funds, and M&A Transactions 75 Strengthening the Corporate Restructuring Process within the Banks 76 Corporate Restructuring in Turkey: The Istanbul Approach 76 Legal Framework and Structure 77 Implementation of the Istanbul Approach 79 Impediments 81 Corporate Restructuring in Mexico 84 Poland: Decentralized Workouts Pursuant to Privatization of State-Owned Banks 86 Lessons Learned 90 References 93 Notes 95Chapter 4Emerging-Market and Crisis Applications for Out-of-Court Workouts:Lessons from East Asia, 1998–2001 99 William P. Mako Corporate-Financial Sector Linkages 101 Recent Approaches to Out-of-Court Workouts 104 Korea 104 Malaysia 104 Thailand 105 Indonesia 106 Results 107 Easy Lessons 110 Principles and Processes 110 Legal and Regulatory Impediments 111 Capacity Constraints 113 vii
  8. 8. Corporate Restructuring: Lessons from Experience Potential Deal Breakers 114 Debtor Losses 114 Creditor Losses 115 Inter-Creditor Differences 117 References 119 Notes 120 Chapter 5 Are More Restructuring Regimes Becoming Like the U.S. Chapter 11 System? 127 James H. Zukin, with the assistance of Alan Fragen and Dorian Lowell Chapter 11 128 Restructuring Regimes in Industrial Countries 130 Requirements of a Rapid-Sequencing Process in Developing Countries 131 The Merits of a Chapter 11 System for Countries 133 Conclusions 135 Appendix 5.1: Questions and Answers on the Current Sovereign Restructuring Process 136 Reference 139 Notes 139 Chapter 6 The Successful Asset Management Companies 141 Ruth L. Neyens, Dató Zukri Samat, Beom Choi, Yang Kaisheng, and Shinjiro Takagi The Role and Progress of Danaharta, Malaysia, Dató Zukri Samat 142 Korea Asset Management Corporation: The Host of Restructuring Vehicles Tried in Korea, Beom Choi 144 China’s Huarong Asset Management Company, Yang Kaisheng 148 China’s Banking Reform 148 Asset Management Companies 149 Restructuring Approaches Used in Japan, Shinjiro Takagi 151 Improvements in the Legal Structure for Corporate Reorganizations 152 The Industrial Revitalization Corporation of Japan 154 Human Resources for Corporate Restructuring 160 Conclusions 161 Appendix 6.1: Civil Rehabilitation Proceeding in Japan 163 Appendix 6.2: Corporate Reorganization Proceeding in Japan 164viii
  9. 9. Contents Appendix 6.3: Out-of-Court Workout in Japan 166 Notes 168Chapter 7Progress toward the Resolution of Nonperforming Loans 171 Jack Rodman The Resolution of Nonperforming Loans 172 Recommendations 180 References 181 Note 181Part II: War Stories from the CrisesChapter 8Restructuring in Weak Legal and Regulatory Jurisdictions:The Case of Indonesian Restructurings 185 Ray Davis Successful Indonesian Restructurings 187 The Impediment of a Weak Court System 188 Effect of Weak Courts on the Rights of Secured Creditors 189 Strong Creditor Organization and Leadership 190 Cash Controls 194 Unexpected Effect of Laws Passed at the Time of the Crisis 195 Role of Government Interventions in Restructuring Negotiations 196 Foreign Government Intervention 196 Preserving the Value of the Enterprise 199 Complexity of Public Debt 199 Summary 201 Notes 201Chapter 9Government Policy Responses in Korea 205 Hogen Oh Note 208 ix
  10. 10. Corporate Restructuring: Lessons from Experience Chapter 10 Malaysia’s Experience withCorporate Restructuring 209 Dató Zainal Abidin Putih Before the Crisis 209 Impact of the Crisis 210 Factors Contributing to the Crisis 211 The National Economic Recovery Plan 213 Banking Restructuring 214 Danaharta 215 Danamodal 217 Corporate Debt Restructuring Committee 218 Corporate Restructuring 218 Conclusions 219 References 220 Notes 221 Chapter 11 An Alternative to Government Management Companies: The Mellon Approach 223 Richard H. Daniel Chapter 12 Corporate Restructuring Funds: The Lessons from Korea 229 Christopher Vale Background 229 Corporate Restructuring Funds 230 The Investment Process 232 Positives and Negatives 233 Part III: Technical Issues Chapter 13 Debt and Firm Vulnerability 237 Jack Glen Data Description 242 Regression Analysis 249 Constituent Components: Sales Margins and Turnover Effects 253x
  11. 11. Contents Country Effects 254 Conclusions 256 References 257 Notes 258Chapter 14The Contingent Claims Approach to CorporateVulnerability Analysis: Estimating Default Risk andEconomywide Risk Transfer 261 Michael T. Gapen, Dale F. Gray, Cheng Hoon Lim, and Yingbin Xiao Contingent Claims Analysis 263 The Contingent Claims Methodology 264 Distance to Distress and Probability of Default 266 Moody’s MƒRisk Model: Contingent Claims Analysis in a Multisector Framework 267 Assessing Corporate Sector Vulnerabilities 269 The Brazilian Corporate Sector 269 The Contingent Claims Approach and Financial Market Uncertainty in Brazil in 2002 272 The Thai Corporate Sector 278 The Contingent Claims Approach and the Asian Financial Crisis 281 Multisector Contingent Claims Analysis 284 Multisector Contingent Claims Analysis: Brazil 285 Multisector Contingent Claims Approach: Thailand 287 Conclusions 290 Advantages of the Contingent Claims Approach 291 Hurdles to Overcome 293 Implications for Macroeconomic Risk Management 294 References 295 Notes 297Chapter 15Developing an Effective Framework for Insolvency andCredit Rights 301 Gordon W. Johnson The Role and Significance of Enforcement and Insolvency Systems 302 Meeting the Challenges of Business in a Global Market 302 Promoting Sound Investment Climates and Commercial Confidence 303 xi
  12. 12. Corporate Restructuring: Lessons from Experience The Risk Assessment Continuum 303 The World Bank Principles and the Risk Assessment Continuum 305 The Commercial Insolvency Framework 306 Are the World Bank Principles Pro-Creditor or Pro-Debtor? 308 Experience with the World Bank Principles under the ROSC Framework 308 Creditor Rights Systems 309 Insolvency Systems 309 Rehabilitation and Reorganization of Businesses 309 Institutional and Regulatory Frameworks 310 Lessons and Experience in Applying the Principles 311 Corporate Restructuring: Common Implementation Goals 312 Corporate Rescue Approaches 312 Formal Proceedings 313 Comparative Tax Consequences for Debt Write-offs 314 Social Protection Systems 315 The Way Forward 316 Appendix 15.1: World Bank Principles and Guidelines for Effective Insolvency and Creditor Rights Systems 317 References 329 Notes 329 Appendix 1 Financial Restructuring: Techniques and Negotiating Dynamics 331 Alan D. Fragen Debt-for-Debt Exchange 334 Situational Overview 334 Situational Assessment 340 The Negotiating Dynamics 344 Debt-for-Equity Exchange 350 The Negotiating Dynamics 368 References 379 Notes 379 Boxes 2.1: Definitions of Restructuring 12 2.2: Cross-Country Experiences with Asset Management Companies 29 2.3: Special Programs and Restructuring Approaches for Small and Medium Enterprises 34xii
  13. 13. Contents 4.1: Enhanced Rules for CDRC Workouts in Malaysia, August 2001 111 4.2: Typical Content of Workout Agreements in Korea 112 8.1: Asia Pulp and Paper 191 8.2: Role of the Mexican Government in Restructuring 197 8.3: Role of the Malaysian Government in Restructuring 198Figures 2.1: Financial Conditions and Performance of the Corporate Sector before the Crisis in Eight Countries 14 3.1: Korea’s Approach to Debt Restructuring, Following the London Approach 70 3.2: Istanbul Approach to Debt Restructuring 78 3.3: Profit Measures for 57 Firms in Bank Conciliation in Poland, 1991–95 90 13.1: Median Interest Coverage Ratio and GDP Growth Rate in Thailand, 1994–2001 241 13.2: Histogram of Interest Coverage Ratio (ICR) for All Countries and Firms, 2000 247 13.3: Interest Coverage Ratio (ICR) for All Brazilian Firms in the Sample, 2000 248 14.1: Distance to Distress 267 14.2: Indicators of Corporate Sector Leverage in Brazil, 1995–2002 270 14.3: Distance to Distress in Brazil, by Sector, March 2002 272 14.4: Distance to Distress in Brazil, by Sector, September 2002 274 14.5: Assets Relative to Distress Barrier in the Utility Sector in Brazil, 2002 275 14.6: Estimated Actual Default Probability Versus Distance to Distress in the Utility Sector in Brazil, March–September 2002 276 14.7: Implied Asset Volatility in the Utility Sector in Brazil, 2002 277 14.8: Assets Minus Distress Barrier in Thailand, 1992 and 1996 281 14.9: Distance to Distress in Thailand, by Sector, July 1997 282 14.10: Distance to Distress in Brazil, by Sector, October 1997 283 xiii
  14. 14. Corporate Restructuring: Lessons from Experience 14.11: Convertibility Risk and Capital Outflows through CC5 Accounts in Brazil, 2002 287 14.12: Financial Sector Distance to Distress in Thailand, 1997 288 14.13: Value of the Financial Sector Guarantee in Thailand, 1997 290 15.1: The Risk Assessment Continuum 304 15.2: The World Bank Principles / ROSC Assessment Framework 306 15.3: Corporate Rescue Approaches 312 Tables 1: Taxonomy of the Role of Government: Legal, Regulatory, Tax, and Financial Engineering Measures xxxiii 2: Employment in Finance, Insurance, Real Estate, and Business Services as a Percentage of Total Employment in Select Countries, 1997 xl 3: Appraisal, Actuarial, and Insolvency Professionals in Select Countries xli 4: Qualification Requirements of Insolvency Experts in Select Countries xlii 2.1: Features of Out-of-Court Corporate Restructuring Processses in Eight Countries 16 2.2: Status of Out-of-Court Corporate Restructuring Processes in Eight Countries, 1999 and 2003 17 2.3: Scope of Out-of-Court Corporate Restructuring in Four East Asian Countries, as of Mid-1999 and Mid-2003 18 2.4: Creditor Rights in Bankruptcy Regimes in Eight Countries, 1999 (or the Crisis Period) and 2003 21 2.5: Effectiveness of Insolvency Systems in Select Regions and Countries 22 2.6: In-Court Restructuring in Four East Asian Countries, of Mid-1999 and Mid-2003 23 2.7: Holdings of Nonperforming Loans and Powers of Asset Management Companies in Eight Countries, 2003 27 2.8: Framework of Regulatory and Loan Restructuring in Eight Countries, as of Early 1997 (Outside of East Asia), 1999 (in East Asia), and 2003 36 2.9: Equity Rights in Eight Countries, as of 1996 and Mid-2003 39 2.10: Share of Nonperforming Loans, Including Shares of Debt Transferred to Asset Management Companies, in Eight Countries, 1998–2003 42xiv
  15. 15. Contents2.11: Corporate Leverage in Eight Countries, 1994–2003 (ratio of debt to assets) 442.12: Interest Coverage Ratio of the Corporate Sector in Eight Countries, 1994–2003 (median of listed firms’ ratio of fixed charge coverage) 462.13: Percentage of Corporations in East Asia with Interest Coverage Less Than 1, 1995–2000 472.14: Profitability of Corporations in Eight Countries, 1994–2003 483.1: Size of Korea’s Corporate Restructuring Program 683.2: Application of Debt Restructuring Methods in Korea 723.3: Corporate Restructuring Measures Agreed as Part of Workouts in Korea, 1999 733.4: Summary of Workouts in Turkey, as of September 30, 2003 803.5: Financial Resolution Paths of 787 Firms in Poland, by Type of Instrument Used 884.1: Overview of Workout Results, by Country 1086.1. Expected Recovery of Danharta in Malaysia, by Method 1446.2: Characteristics of Three Workout Vehicles Used in Korea 1467.1: Official Estimates of Nonperforming Loans in Select Markets 1727.2: Characteristics of Markets for Nonperforming Loans, by Status of the Market 1737.3: Definition of and Annual Return in Markets for Nonperforming Loans, by Status of the Markets 17313.1: Number of Firms, by Economy and Year, 1994–2001 24313.2: Number of Firms, by Economy and Sector, 2000 24513.3: Median Ratio of EBITDA to Interest Expense (ICR), by Economy and Year, 1994–2001 24613.4: Regression Models 25113.5: Regression Models 25413.6: Country Fixed-Effects Regression 25514.1: Leverage and Debt Structure of Nonfinancial Companies, Brazil, December 2001 27114.2: Gross External Borrowing by the Non-Bank Sector, Thailand, 1992–96 279 xv
  16. 16. Corporate Restructuring: Lessons from Experience 14.3: Borrowing Terms of Private External Loans, Thailand, 1992–96 280 A.1: Historic and Projected Income Statement, OpCo, Fiscal Year Ended December 31, 2000–07 335 A.2: Historic and Projected Cash Flow Statement, OpCo, Fiscal Year Ended December 31, 2000–07 336 A.3: Historic and Projected Balance Sheet, OpCo, Fiscal Year Ended December 31, 1999–2007 338 A.4: Actual versus Estimated Balance Sheet as of December 31, 2003 339 A.5: Valuation Analysis, OpCo 340 A.6: Analysis of Liabilities, OpCo, as of December 31, 2003 341 A.7: Analysis of Debt Capacity, OpCo 342 A.8: Key Terms of the Negotiated Restructuring Proposal, OpCo 350 A.9: Balance Sheet Before and After Restructuring and Accounting Adjustments Made for the Exchange, OpCo 351 A.10: Sources and Uses of Funds for the Leveraged Recapitalization, OpCo 352 A.11: Historic and Projected Income Statement Following Leveraged Recapitalization, OpCo, Fiscal Year Ended December 31, 2000–07 354 A.12: Historic and Projected Cash Flow Statement Following Leveraged Recapitalization, OpCo, Fiscal Year Ended December 31, 2000–07 355 A.13: Historic and Projected Balance Sheet Following Leveraged Recapitalization, OpCo, Year Ended December 31, 1999–2007 356 A.14: Actual versus Estimated Balance Sheet Following Leveraged Recapitalization, OpCo 357 A.15: Comparison of a Consensual Sale Versus a Contested Deal, OpCo 360 A.16: Projected Income Statement in Debt-for-Equity Exchange, OpCo, Fiscal Year Ended December 31, 2000–07 363 A.17: Projected Cash Flow Statement Following Debt-for-Equity Exchange, OpCo, Fiscal Year Ended December 31, 2000–07 364 A.18: Projected Balance Sheet Following Debt-for-Equity Exchange, OpCo, Fiscal Year Ended December 31, 1999–2007 365 A.19: Absolute-Priority Distribution Analysis Following Debt-for-Equity Exchange 366 A.20: Results for Old Equity of a Negotiated Settlement That Converts Unsecured Credit into Equity 367xvi
  17. 17. ContentsA.21: Holdout Analysis Using Low End of the Valuation Range, OpCo 372A.22: Proposed Full Conversion of Debt to Equity, OpCo 375 xvii
  18. 18. PrefaceThe severe financial crises that devastated emerging markets over the pastdecade underlined important gaps in our ability to deal with corporatedistress. The Asian crisis, and ensuing crises in Turkey and Argentina, ledto massive declines in output and corporate profitability and to widespreadcorporate insolvencies. Moreover, corporate difficulties are not limited tocountries that have suffered a recent, spectacular crisis. In many countries,corporate weaknesses or “silent” distress may be setting the stage for futurefinancial crises. There is no magic bullet for addressing systemic corporatedistress. Coping with it requires a host of simultaneous measures, such asfinancial engineering techniques for restructuring, consideration of theimpact of the tax system on incentives for restructuring, policy approachesto the disposal of bad debts, efforts to strengthen bankruptcy courts andthe legal framework for insolvency, and the establishment of procedures forout-of-court workouts. It has become clear that governments, as well as themultilateral institutions, often lack the resources and expertise required toaddress corporate distress on a large scale and that policies, institutions, andlegal frameworks may not be adequate to the task. A scarcity of skills (legal,financial) in the private sector and in the judiciary is also found to be animpediment in many countries. xix
  19. 19. Corporate Restructuring: Lessons from Experience The World Bank organized a conference in March 2004, entitled Corporate Restructuring—International Best Practices, to improve our understanding of how to cope with systemic corporate distress. This confer- ence brought together policymakers, regulators, investment bankers, tax lawyers, and other restructuring specialists to share their experiences with corporate restructuring in crises. The emphasis was heavily toward practical solutions, with the goal of helping participants to learn what has worked and what has not. The high quality of presentations, significant interest in exchanging ideas during discussions, and substantial participation from some of the leading experts in corporate restructuring were gratifying for those of us involved in organizing the conference. This book collects the papers presented at the conference. It provides an overview of the state of corporate distress and efforts at restructuring, dis- cusses approaches to monitoring corporate distress, reviews the main policy lessons from systemic corporate crises, and evaluates the success of different financial techniques for restructuring troubled debtors. The opening chapter advocates an integrated approach to corporate restructuring, and an intro- ductory chapter distills the key lessons from the papers gathered in this vol- ume. We hope that the book will be of benefit to our clients that confront systemic corporate distress and will make some contribution to improving crisis prevention and reducing the costs of recovery. CESARE CALARI Vice President, Financial Sector World Bankxx
  20. 20. AcknowledgmentsThis volume relies extensively on presentations at the CorporateRestructuring: International Best Practices conference hosted inWashington, D.C., by the World Bank Group in March 2004. We wouldlike to acknowledge the efforts of the participants at the conference as wellas those of the contributors to this book. We are also indebted to the referees(Sri-Ram Aiyer, Won-Dong Cho, and Bob Litan) and to the peer reviewers(Lily Chu, Stijn Claessens, Sophie Sirtaine, and V. Sundararajan), whoseinsights enriched the manuscript. In addition, we thank Colleen Mascenikfor providing research assistance, Elizabeth Forsyth for editing the manu-script, James Quigley for designing the book, and Myrvet Alyeldin Cocoliand Sema Muslu for providing administrative support. xxi
  21. 21. ContributorsBeom Choi is executive director of the International Business Group ofKorea Asset Management Corporation (KAMCO). He manages interna-tional relations and is the main liaison officer with government restructur-ing agencies in China, Indonesia, Japan, Malaysia, and Thailand. He is alsothe coordinating officer of the Nonperforming Loan Forum, which involvesmore than 800 executives from over 15 countries, and has headed teamsin the Corporate Disposition and Investment Management departments.Prior to joining KAMCO, he was head of Equity Sales at the Seoul Branchof Credit Suisse First Boston (1996–98) and head of Equity Business andCorporate Finance for the Seoul Branch of W. I. Carr (1994–96). He holdsa BA in finance from the University of Wisconsin, a degree from HankookUniversity of Foreign Studies in Korea, and an MBA from WesternMichigan University.Stijn Claessens has rejoined the World Bank after teaching internationalfinance at the University of Amsterdam. He has worked in the World Bankin various capacities, including as lead economist of the Financial SectorStrategy and Policy Group, Financial Sector Operations Vice Presidency. Hehas led World Bank missions to numerous countries, helping governmentsto develop strategies for external debt restructuring and asset-liability man- xxiii
  22. 22. Corporate Restructuring: Lessons from Experience agement and providing advice on financial sector restructuring and reform. He has lectured and published extensively on external finance and domestic financial sector issues. He holds an MA in business economics from Erasmus University, the Netherlands, and an MA and a PhD in business economics from the Wharton School of the University of Pennsylvania. Richard H. Daniel retired in mid-1993 as vice chairman, director, and chief credit officer of Mellon Bank, where he managed the corporation’s credit-related functions. He came to Mellon in 1986, with more than 35 years of credit experience, developed largely through a long career with Security Pacific National Bank, Los Angeles, and a year as executive vice present in charge of the Special Assets Department of Crocker National Bank. He is a founding member of Robert Morris Associates, served as director of the organization’s domestic lending division, and founded the Senior Workout Officers’ Roundtable. He holds a BS from the University of California, Berkley, and is a graduate of the Pacific Coast Banking School in Seattle. Ray Davis leads RN Davis & Company, an advisory firm executing merg- ers and acquisitions and restructuring assignments with clients in North America and Asia. He is a former managing director of Credit Suisse First Boston, where he spent more than five years working on restructuring assign- ments in Asia, Europe, and the Middle East, and spent 16 years at Lehman Brothers, both in the Restructuring Group and the Oil and Gas Group. He worked extensively in Mexico after the peso crisis and has been involved in numerous in-court and out-of-court restructurings in Canada and the United States. Before joining Lehman Brothers, he worked for the U.S. Department of Energy and taught finance at Emory University and Temple University. He has a BS in mechanical engineering from the University of Pennsylvania, an MBA from Temple University, and a DBA from Indiana University. Alan D. Fragen is managing director in the Financial Restructuring Group in the Los Angeles office of Houlihan Lokey Howard & Zukin. Over the past 12 years, he has managed numerous complex restructurings, including assignments that incorporate distressed merger and acquisition activity and outside capital-raising events. He is an expert in the communications indus- try and in the precious and base metals mining and processing industries. Hexxiv
  23. 23. Contributorsholds a BA in economics and mathematics from Northwestern Universityand an MS in econometrics from the London School of Economics andPolitical Science.Michael T. Gapen is an economist in the Capital Markets FinancingDivision of the International Monetary Fund (IMF). He has participatedin IMF missions to Iceland, Panama, Suriname, and, most recently, Brazil,where he focused primarily on capital market issues. Prior to joining theIMF, he was a visiting assistant professor in the Mendoza College of Businessat the University of Notre Dame.Jack Glen is lead portfolio officer in the Portfolio Management Departmentof the International Finance Corporation (IFC). Before joining the IFC in1991, he taught international corporate finance at the Wharton School. Hehas a PhD in international finance from Northwestern University.Mario Gobbo is in charge of Life Sciences Investments for the InternationalFinance Corporation, a World Bank Group institution dealing with privatesector investments. He previously worked with Lazard Brothers in London,where he managed the company’s Central and Eastern European practice.In 1982 he began his career as a banker in Milan with Continental IllinoisNational Bank and subsequently moved to London, where he worked withSwiss Bank Corporation International, among others. He has more than20 years of banking experience, which spans pharmaceuticals and biotech-nology as well as oil and gas, telecommunications, power, and financialinstitutions. He has a BA from Harvard College, an MSc from Universityof Colorado; an MBA, an MA in business economics, and a PhD fromWharton School, University of Pennsylvania.Dale F. Gray is president of Macro Financial Risk Corporation, MƒRisk.In a joint venture, Moody’s Investors Services and MƒRisk have developedweb-based interactive models for more than 18 countries and provided mac-rofinancial research for banks, investors, and international institutions. From1995 to 1998, he was an adviser at the International Monetary Fund for theRussia Team, working on capital market development and corporate andfinancial sectors, and for the Fiscal Affairs Department. From 1985 to 1995,he worked at the World Bank on Eastern Europe, Former Soviet Union,Middle East, and major Latin American countries. From 1982 to 1985, he xxv
  24. 24. Corporate Restructuring: Lessons from Experience was an adviser to the minister of finance and the central bank in Indonesia. He has an MA from Stanford University and a PhD from Massachusetts Institute of Technology; he is a certified financial risk manager. Gordon Johnson is legal counsel for the World Bank on matters pertaining to corporate insolvency and creditor rights systems. He has experience in approximately 40 emerging-market countries on matters of legal, judicial, and regulatory reform and routinely provides legal support to emergency recovery teams in crisis situations, such as Argentina and Turkey. He spearheaded the Bank’s Insolvency Initiative, in collaboration with international partners, to develop the Principles and Guidelines for Effective Insolvency and Creditor Rights Systems, a benchmark for assess- ing the effectiveness of country systems worldwide. Prior to joining the Bank, he practiced for more than a decade with the international law firm of Weil Gotshal & Manges in the areas of business finance and restruc- turing and electrical power transactions He holds a BS from Abiline Christian University, a JD from Pepperdine University School of Law, and an LLM in international banking and finance from the University of London. Yang Kaisheng is president of China’s Huarong Asset Management Corporation, an independent legal entity, a wholly state-owned financial institution, and the largest of four asset management companies. Founded by the government to tackle the problem of nonperforming loans and support the reform of China’s state-owned enterprises, Huarong purchases, manages, and disposes of the nonperforming loans acquired and maximizes the recov- ery value, while minimizing any losses resulting from the disposition. Ira Lieberman is former senior adviser to the World Bank and a senior adviser to the Open Society Institute of the Soros Foundation. Cheng Hoon Lim is deputy division chief in the Capital Markets Financing Division of the International Monetary Fund. She joined the IMF in 1994 and has worked primarily on crises in emerging markets, including Korea during the Asian crisis and, more recently, Argentina and Turkey. She was banking supervisor at the U.K. Financial Services Authority and has worked at the Urban Development Division of the World Bank. She has a PhD in applied macroeconomics from Cambridge University.xxvi
  25. 25. ContributorsDorian Lowell is senior vice president of Houlihan Lokey Howard andZukin, an international investment bank established in 1970 that providesa wide range of services in the areas of mergers and acquisitions, financing,financial restructuring, and merchant banking.William P. Mako is lead private sector development specialist in theBeijing Office of the World Bank. He has worked in various regions andcountries, advising authorities on measures to alleviate and resolve cor-porate distress, on procedures and institutional arrangements to facilitatecorporate workouts, and on the development and implementation of enter-prise privatization and capital markets programs. Prior to joining the WorldBank, he worked at PriceWaterhouse from 1983 to 1997 and at Booz Allen& Hamilton in 1982. In the United States, he has experience in Chapter11 and Chapter 7 insolvency cases. He holds a BS in foreign service fromthe Georgetown School of Foreign Service and an MA in public and privatemanagement from Yale University, School of Management.Ruth Neyens is program manager of Banking and Financial Restructuring,Operations and Policy Development in the World Bank’s Financial SectorVice Presidency. She is responsible for developing and delivering a compre-hensive program focused on strengthening banking supervision and regula-tion, improving the performance of banks through restructuring, and under-taking corporate restructuring, including asset management. She has servedas program manager for financial sector reform in Indonesia and providedadvice and technical assistance in these areas in Argentina, Bolivia, Korea,and Turkey. Before joining the Bank, she was senior vice president at Bankof America, responsible for asset resolution. In addition, she has held seniorpositions in credit risk management and credit training. She has taughtfinance and bank management courses at the University of Maryland.Hogen Oh is chairman of Lazard Asia, which provides strategic andmerger and acquisitions advisory services for multinational and major Asiancorporations. From 1998 to 2000, he was executive chairman of Korea’sCorporate Restructuring Committee, where he chaired a special committeeto evaluate so-called Big Deals. He also served as chairman of the CorporateRestructuring Committee and the board of directors of Daewoo Companies,where he supervised and coordinated all restructuring efforts. He has servedas representative for the Global Strategic Service (1994–98), as chair- xxvii
  26. 26. Corporate Restructuring: Lessons from Experience man of Younglim Cardinal, Publishers (1992–99), as chairman and chief executive officer of the Korea Merchant Banking Corporation (1984–90), and as a member of the Advisory Committee to the Minister of Finance (1982–90). He holds a BA in economics and an MA in economics from Pace University. Michael Pomerleano is lead financial sector specialist in the Financial Sector Operations and Policy Department of the World Bank. He has extensive international financial consulting experience in Asia and in the transitional economies of Eastern Europe and Central Asia, advising gov- ernments, central banks, and commercial banks on financial sector reform. Before joining the World Bank in 1992, he worked for the National Banking Group of Citicorp, was managing partner of MBC Associates (an owner- operator of commercial real estate), and worked in the supervision and regulation division of the board of governors of the Federal Reserve System. He has an MA in business economics, a joint degree awarded by the Harvard Business School and Harvard Economics Department. Dató Zainal Abidin Putih is chairman of the Pengurusan Danaharta Nasional Berhad. He is a fellow of the Institute of Chartered Accountants of England and Wales, a chartered accountant of the Malaysian Institute of Accountants, and a certified public accountant of the Malaysian Institute of Certified Public Accountants. He has extensive experience in the audits of banks, insurance, energy, transport, manufacturing, government agen- cies, plantations, properties, hotels, investment companies, unit trusts, distributors, timber, and wholesalers. He is joint chairman of Ernst & Young Malaysia and chairman of the Malaysian Accounting Standards Board. Jack Rodman is managing director of Asia-Pacific Financial Solutions, a profit center he founded within Ernst & Young in 1995 to provide finan- cial services related to the nonperforming loans of banks and government agencies in the Asia Pacific. He was credited by the Wall Street Journal with creating a market for the sale of nonperforming loans in China and Japan. Before founding Asia-Pacific Financial Solutions, he worked with Kenneth Leventhal & Company for more than 30 years, holding several senior man- agement positions with the firm. He has a BA in accounting from San Jose State University and an MA in business administration from the University of California, Los Angeles.xxviii
  27. 27. ContributorsDató Zukri Samat is managing director of Pergurusan DanahartaNasional Berhad, Malaysia. At Danaharta, he has held various positions,including general manager and director of the Operations Division. Hehas wide experience in the banking sector, having served both local andinternational financial institutions in various capacities. Prior to joiningDanaharta, he was general manager of Credit Agricole Indosuez Labuan andworked in Commerce International Merchange Bankers Berhad. He holdsan MBA from the University of Hull, United Kingdom.William Shaw is former lead economist in the World Bank’s DevelopmentProspects Group. Since joining the research department in 1995, he workedon various editions of Global Economic Prospects and Global DevelopmentFinance (the Bank’s annual publications on current development issues)and on debt sustainability analysis for the Heavily Indebted Poor CountriesInitiative. From 1988 to 1995, he worked in the Bank’s operational depart-ments, serving as the country economist for Tanzania, private sector devel-opment specialist for the Caribbean, and country economist for Bolivia.Before joining the Bank, Mr. Shaw worked on the administration of a foodassistance program for the U.S. Department of Agriculture. Since retiringfrom the Bank, Mr. Shaw has served as a consultant on various issues indevelopment economics.Shinjiro Takagi is chairman of the Industrial Revitalization Committee ofthe Industrialization Revitalization Corporation of Japan. The committeeexamines the restructuring plans of companies, identifies which companiesto support, and determines the purchase price of loan claims from nonpri-mary lenders. Mr. Takagi formerly served as Justice of the Tokyo High Courtand is an experienced lawyer.Christopher Vale is founding director of Rexiter Capital Management,a London-based global emerging markets fund manager. He has managedtwo corporate restructuring funds in Korea: Arirang and Mukoonghwa.Before founding Rexiter Capital Management, he worked for KleinwortBenson Investment Management (KBIM) as a U.K. fund manager. In 1989he transferred to the Hong Kong Office of KBIM, where he spent eightyears managing Asian funds primarily for U.S. and U.K. clients. He becamehead of KBIM’s Asian Team and a director of KBIM in 1994. He has a BA xxix
  28. 28. Corporate Restructuring: Lessons from Experience in economics and agricultural economics from the University of Exeter, United Kingdom. Yingbin Xiao is an economist in the Capital Markets Financing Division of the International Monetary Fund. She has performed financial analysis on the Argentine corporate sector, highlighting balance sheet risks facing the sector, and has conducted a comparative study of trade and investment liberalization. She holds an MS in financial engineering, an MA in econom- ics, and a PhD in financial economics from the University of Michigan, Ann Arbor. James H. Zukin is senior managing director and founding board member of Houlihan Lokey Howard & Zukin, an international investment bank established in 1970 that provides a wide range of services in the areas of mergers and acquisitions, financing, financial restructuring, and merchant banking. Prior to joining Houlihan Lokey in 1976, Mr. Zukin was founder and director of the ESOT Valuation Group at Marshall & Stevens and vice president for mergers and acquisitions at Niederhoffer, Cross & Zeckhauser. He has a BA in economics from the University of California, Berkeley, and an MBA from Harvard Business
  29. 29. Introduction: Toward Better Practicesin Systemic Corporate RestructuringMichael PomerleanoRecent systemic crises have underlined how widespread, severe weaknessesin corporate finance and governance, combined with inappropriate mac-roeconomic policies or a sudden loss of confidence, can have unforeseenand extremely serious consequences for the economic and social fabric ofa country. Paul Romer, the Stanford economist, remarked: “A crisis is aterrible thing to waste.” Those are profound words and resonate true for atleast three reasons. First and most obviously, a crisis is a terrible and costlyevent. The recent fiscal costs of recapitalizing banks during the Asia crisisare estimated at 28 percent of GDP in Malaysia and over 55 percent of GDPin Indonesia (Caprio 2003). The crisis-induced decline in GDP has beenas great as 10 percent of GDP, and hard-to-quantify intangible costs mayinclude slow growth and lower long-term productivity if bank and corporaterestructuring is not successful. Second, the recent corporate crises under-lined the gaps in our ability to deal with corporate distress. Crises can teachus what works and what doesn’t, although we need to continue searchingfor additional practical solutions that were not tried during the crisis.1 And,finally, crises may make it possible to force through necessary but politicallydifficult changes in law, policies, and institutions. This chapter seeks to distill the lessons from recent crises and offers arange of suggestions, some of them controversial, on measures to help pre- xxxi
  30. 30. Corporate Restructuring: Lessons from Experience vent crises and manage recovery. Recommendations are grouped into five sections, covering the role of government, the legal framework for corporate restructuring, the tax regime, skills required for restructuring, and financial engineering techniques. Clearly, one size does not fit all, and these recom- mendations will need to be adapted to the circumstances and conditions in a specific country. Measures that are acceptable in a disciplined setting where the culture is homogeneous might not be enforceable in a country where the rule of law is ineffective. The Government’s Role Governments have been intensively involved in resolving systemic crises, including extensive interventions in the process of corporate restructuring, driven by the huge costs of crises, the government’s responsibility (explicit or implicit) for the banking system, and the necessity of addressing wide- spread business failures and unemployment (see table 1). The role of gov- ernment should be considered in terms of steps to monitor and intervene in the corporate sector prior to a crisis, ways to organize the immediate response to a crisis, the strategy for addressing corporate and financial sector insolvency, and creation of an appropriate regulatory framework for corpo- rate restructuring. Monitoring Officials responsible for economic policy, as well as the public at-large, need adequate information on the financial soundness of the corporate sector. For example, while some of the weaknesses of East Asian businesses, such as poor governance and high leverage, were recognized prior to the 1997 crisis, the full impact of cross-guarantees and the extent of foreign exchange exposure in corporate finances were not fully understood until after the fact. In Indonesia, for instance, private corporations were borrowing directly offshore. Because the international bank debts were owed mainly by the corporate sector, public officials did not have adequate data on the extent of foreign debt incurred. Thus government could not properly evaluate the impact of foreign exchange depreciation on the solvency of the corporate sector and on the economy as a whole. Establishing a central monitoringxxxii
  31. 31. Table 1: Taxonomy of the Role of Government: Legal, Regulatory, Tax, and Financial Engineering Measures Extent of intervention Issue Agency responsible Prevailing practice Measures or intrusion Information on the financial soundness Ministry of finance or Limited: Colombia Collection and analysis of Low of the corporate sector central bank (Superintendency of data Companies) Tax regime Ministry of finance or tax Carry of losses; deductibility Low agency of write-offs Effective insolvency regime in terms of Justice department Some: for example, Specialized courts Medium legislation and capacity Colombia (Superintendency of Companies), Korea, Malaysia, the Philippines, and the United States (Securities and Exchange Commission) Out-of-court infrastructure Banking supervision and Some: for example, Medium regulation agency Thailand Financial engineering, such as asset Ministry of finance, central Some: for example, Korea Funding for asset High management companies, corporate bank, tax authority, justice management companies, restructuring funds, corporate department corporate restructuring restructuring vehicles, secondary funds; legal setting for market in distressed debt securitizations Regulatory initiatives Banking supervision and One: Korea Corporate deleveraging and Very high regulation agency corporate action plans Introductionxxxiii
  32. 32. Corporate Restructuring: Lessons from Experience unit within the government offers the advantage of developing and central- izing expertise for monitoring the corporate sector. This government unit could take on the responsibilities for detailed data collection. The kinds of data that might be recorded include the composition of corporate debts, exchange rate denomination of debt, residence of debt owners, profit and loss accounts, and governance structures. The amount of resources devoted to these efforts would vary, depending on fiscal resources, the nature of corporate vulnerabilities, and the level of development. It would be important to minimize the burden of data collection on companies and to take into account legitimate needs for confidentiality. In some countries, government might be able to rely on private companies (for example, credit bureaus and rating agencies) to collect the data or might assign this respon- sibility to bank supervisors. This government unit also could take on coordi- nating responsibilities relative to ongoing corporate restructuring and act as an advocate within the government to push for the legal, regulatory, tax, and financial engineering reforms aimed at creating a sound corporate sector. One of the few examples of a government agency devoted to corpo- rate sector monitoring and intervention is Colombia’s Superintendency of Companies. Centralizing this responsibility within a government department was seen as necessary because the judicial system did not have sufficient expertise or capacity in business matters and was often ineffective in resolv- ing insolvency proceedings. For example, before 1995 some companies had been in the process of liquidation for more than 12 years without paying their debts, and this was having an adverse impact on financial institutions. The Superintendency of Companies was established to monitor and, on occasion, intervene in businesses with the goal of preventing crises, ensur- ing confidence in the legal system, and generating reliable accounting and financial data to ensure transparency. The superintendency can review any company that is registered with the Chamber of Commerce, for the purpose of obtaining all information necessary to understand the company’s legal, accounting, economic, and administrative status. It also oversees corporate restructuring and has the capacity to enforce compliance when companies are found to be in violation of laws. Intervention The extent to which an agency should intervene in corporate decisionmak- ing prior to a crisis is controversial. Government officials may lack suf-xxxiv
  33. 33. Introductionficient information to make efficient decisions on corporate restructuring.Moreover, in some cases, government interventions may simply serve theinterests of particular corporate groups with influence on government. Theability of government to intervene, and the effectiveness of interventions,will depend greatly on the country context and specific circumstances.For example, the Korean government made concerted efforts to force thefive big chaebols to rationalize operations through mergers (the so-calledBig Deals) in the midst of the crisis, with debatable results. In Republic ofKorea, where close ties had long existed between government and corporateinterests, it is possible that using government influence to help rationalizethe chaebols prior to the crisis might have been more effective. In most cases, however, government interventions in corporate restruc-turing have come in the aftermath of a crisis. And, typically, interventioniststeps have been taken either through the banking system—for example,Korea’s enforcement of benchmarks for corporate deleveraging by stipulat-ing that banks could not lend to corporations that did not meet these tar-gets—or by government agencies that have purchased nonperforming loansand thus become creditors of bankrupt companies and perforce involved intheir restructuring. In this context, the government strategy for dealing withcorporate restructuring is critical to the prospects for recovery from systemiccrises. The agency responsible for restructuring insolvent companies shoulddivide corporations by size and by viable versus nonviable companies. Thisshould enable the agency to focus on the largest debtors that warrant imme-diate attention. Government needs to demonstrate its determination toliquidate companies that have little prospect of survival and to force viablecompanies to take the necessary financial and operational steps to regainsolvency. A firm stand is required to avoid moral hazard. Korea learned thislesson the hard way, as policymakers believed that the largest chaebols were“too big to fail.” With the exception of Daewoo, the seven largest chaebolswere allowed to undertake voluntary restructuring along the lines of the BigDeals, which went nowhere after months of talk. Governments should forge stronger links between corporate and bankrestructuring. It is impossible to address the problems of banks success-fully without addressing the underlying problem of bad corporate loans. Bycontrast, rehabilitating banks with the intention of addressing corporateweaknesses at a later time is a recipe for failure: banks can be recapitalized,but they remain with a huge portfolio of bad loans. Turkey adopted this xxxv
  34. 34. Corporate Restructuring: Lessons from Experience approach, in anticipation that a more robust financial system would be in a better position to restructure the corporate sector, with poor results. An integrated approach to bank and corporate restructuring often involves put- ting pressure on the banks to address corporate weaknesses, as was done in Korea. Malaysia’s experience is a valuable model for tackling corporate and bank restructuring in unison. The National Economic Action Council, created in January 1998 as a high-level consultative body (including the prime minister and governor of the central bank), formulated an agenda for comprehensive restructuring of the banking and corporate sectors. Three agencies—Danaharta, Danamodal, and the Corporate Debt Restructuring Committee (CDRC)—were established for this purpose: Danaharta was an asset management company with functions similar to those of the U.S. Resolution Trust Corporation; Danamodal Nasional Berhad was established to recapitalize the banking sector, especially to assist banks whose capital base had been eroded by losses; and CDRC was established to reduce stress on the banking system and to repair the financial and operational positions of corporate borrowers. These three agencies linked their efforts effectively. A bank in trouble because of the huge amount of bad loans on its books could see Danaharta to sell its nonperforming loans. Thereafter, if the bank was still in financial trouble and the shareholders could not recapitalize, the bank could seek financial assistance from Danamodal, at a cost. Effectively, new money would be injected into the bank, diluting the original share- holders. This meant that Danamodal could facilitate consolidation of the sector by selling its stake to a stronger bank and thereby fostering mergers. Meanwhile, CDRC acted as an informal mediator, facilitating dialogue between borrowers and their creditors to achieve voluntary restructuring schemes. If CDRC could achieve this, then nonperforming loans would be resolved voluntarily. If not, Danaharta would take over the bad loans. While the government needs to be actively involved in the resolution process, this role should rely, to the extent possible, on market forces rather than government fiat to establish the right incentives for sound financial behavior. For example, an appropriate mix of carrots and sticks can induce financial institutions to take steps to resolve nonperforming loans, such as by conveying excess nonperforming loans to an asset management company for resolution. Time-bound capital adequacy forbearance might be appropriate where the deteriorating capital position is attributable to the disposition of nonperforming loans.xxxvi
  35. 35. Introduction The application of sticks and carrots in Taiwan (China) offers a modelfor reducing substantially banks’ nonperforming loans. Taiwan (China)initially had difficulty finalizing the sale of nonperforming loans. However,President Chen Shui-Bian imposed stringent rules (the 2-5-8 Plan), whichspecified that, in two years, all banks were to reduce their bad loans to below5 percent and to achieve an 8 percent risk-adjusted capital ratio. Banks thatfailed to achieve these goals were subject to a series of restrictions, includingno new branches, lower salaries for directors and supervisors, and limitedhiring, long-term investment, and loans to related parties. Banks that con-tinued to miss the plan’s targets could be subjected to fines, replacement ofmanagement, and revocation of their banking license. At the same time, taxholidays were implemented, while other regulations were eased or removed.This approach and its decisive execution by the government was a hugesuccess: in the 18 months after initiation of the program, 25 market saletransactions to third-party investors were completed. In other countries, banking laws and regulations may impede restructur-ing, and time-bound relief might be appropriate during a crisis. Banking lawsor regulations may restrict the amount of converted corporate equity that afinancial institution can hold or else require its prompt sale. Moreover, pre-emptive rights of shareholders may delay or obstruct debt-equity swaps, andtherefore minority shareholders may hold out for preferential terms.Legal Framework for Corporate RestructuringMany countries need to strengthen the legal framework governing corporatebankruptcy, including improving laws, training court personnel, and mak-ing administrative systems more efficient. In several countries hit by crises,the legal system provides insufficient protection for creditor rights, greatlyimpeding progress in the resolution of bankrupt companies. An effective insolvency framework is the prerequisite for efficientcorporate restructuring and, indeed, is an important support for financialintermediation. Weak creditor rights and slow enforcement limit recover-ies and raise the risk of lending, thereby reducing access to credit. Effectiveinsolvency systems serve as a disciplinary force in establishing a deterrentagainst which voluntary corporate restructuring takes place, both in and outof court. xxxvii
  36. 36. Corporate Restructuring: Lessons from Experience The goals of an insolvency framework should be to reduce legal and financial uncertainty, promote efficiency, and provide fair and equitable treatment of stakeholders in the insolvent firm. There are clear advantages to a Chapter 11–style bankruptcy reorganization framework, which helps to facilitate asset resolution in a way that minimizes the deterioration of asset values, supports the continuity of operation for viable firms, and allows the transfer of the assets of nonviable firms to better uses. However, Chapter 11–style bankruptcy processes can also provide scope for delays and require a highly specialized judiciary. The huge number of bankruptcies in the aftermath of crises, in conjunc- tion with existing weaknesses in the court system, requires the establishment of officially sanctioned out-of-court workout processes. It is essential for such processes to include time-bound measures that enforce the resolution of disagreements between debtors and creditors. Corporate restructuring agencies that oversee out-of-court workouts should have the authority to terminate the mediation and refer the case for initiation of bankruptcy pro- ceedings. Korea’s adoption of the London approach illustrates the value of binding deadlines and mechanisms for resolving inter-creditor differences. The typical medium-size Korean corporation, with a financial exposure of $1.5 billion, usually has anywhere between 40 and 60 institutions lending to it in one form or another. With so many creditors, it could be difficult to achieve the 75 percent threshold for agreement provided for in the accord. Therefore, the accord provided for a corporate restructuring committee, with an executive chairman, which would review proposals for corporate restructuring. If 75 percent of the creditors could not reach agreement, the restructuring proposal would be submitted to the committee, which then would issue a binding judgment on it. Out-of-court workout processes, while essential for many of the crisis countries, can also exacerbate delays and uncertainty, especially when the majority shareholders are ill intended. In Thailand in the case of Thai Petrochemicals, for instance, the procedures were slow and gave the intran- sigent majority owner enormous scope for delay. Thus out-of-court restruc- turing should be governed by clear principles and processes, including: • A corporate restructuring accord among domestic and international creditors that binds all the creditors and contains binding deadlinesxxxviii
  37. 37. Introduction • Reliable mechanisms to resolve differences among creditors—that is, a reasonable threshold for binding agreements and cram-down (for example, 75 percent) • A coordination committee that arbitrates inter-creditor differences and binds the creditors.Tax IssuesIn virtually all of the developing countries, tax impediments to corporaterestructuring exist and can bring the corporate restructuring process to agrinding halt. There are several recurring types of tax impediments. The taxtreatment of debt may forbid creditors from claiming a tax deduction for dis-charged debt and may treat forgiven debt as taxable income for the debtor.In other countries, mergers and acquisition transactions can generate a tax-able event. For instance, in some cases, tax losses cannot be assumed by theacquiring corporation. The transfer of distressed debt to a pool such as a trustmay be considered a sale and therefore generate sales or transfer taxes. Restructuring should be viewed as an ongoing process and be permitted totake place for reasons of economic efficiency rather than tax considerations.Therefore, it is desirable to enact tax policies that are neutral to corporaterestructuring. However, in periods of severe corporate distress, governmentshave introduced time-bound tax incentives designed to accelerate corporaterestructuring. For example, in Thailand, the government recognized theimpediments and specified temporary and permanent measures to facilitatecorporate restructuring. The temporary measures were intended to enabledebtors and creditors to speed up the restructuring process and were set toexpire by December 31, 1999. They included (a) deduction of written-offdebt from the taxable income of the creditor, (b) elimination or deferral ofcorporate income tax on written-off debt for the debtor, (c) elimination ofall taxes on asset transfers from debtor to creditor, and (d) elimination oftaxes on accrued but unpaid interest and limitation of taxes on restructur-ings that involve interest rate reductions by creditors. Permanent measuresdesigned to support corporate restructuring included (a) provision for tax-free mergers and non-cash acquisition of assets in the case of full mergersand (b) elimination of the value added tax and specific business tax on thetransfer of assets to special-purpose vehicles. xxxix
  38. 38. Corporate Restructuring: Lessons from Experience Skills and Capacity The buildup, duration, and severity of corporate crises, as well as the restructuring that occurs in the aftermath of crises, are related to the avail- ability of skills in financial sector services (see table 2). Countries that have capable professionals such as appraisers and insolvency experts recognize and respond more swiftly to crises than countries with a limited base of expertise. The same is true of countries with a wide range of investment and risk management mechanisms, including a secondary market for debt, corporate financial restructuring funds, corporate restructuring vehicles, real estate investment trusts, and securitization. However, the development and implementation of such instruments require a solid base of human capital, including insolvency experts, appraisers, financial analysts, and actuaries. The Asian financial crisis has led to calls for the development of inter- national standards with the intent of strengthening public financial institu- tions, particularly in areas such as securities and bank regulation. There is an equal need to strengthen the capacity of the private financial sector through international standards in the essential professions and improvements in the institutional setting. Critical professions that are lacking and whose absence impedes the process of restructuring include insolvency experts, lawyers, accountants, appraisers, financial analysts, and actuaries (see table 3). Effective regulations can increase the efficient supply of such profession- als by establishing standards for quality (see table 4), introducing safeguards against fraud, and establishing requirements that encourage private sector demand (for example, requiring proper audits increases the demand for audi- tors, thus raising their salaries and encouraging more entrants to the field). Governments should also abolish restrictions on foreign competition to encourage greater access to professionals. There is ample evidence that the Table 2: Employment in Finance, Insurance, Real Estate, and Business Services as a Percentage of Total Employment in Select Countries, 1997 Country Share of total employment Indonesia 0.754 Philippines 2.442 Malaysia 5.219 Japan 8.769 United States 11.399 Source: United Nations (1997).xl
  39. 39. Introductionpresence of foreign banking, insurance, and securities benefits the sectorsin which they invest (Litan, Masson, and Pomerleano 2001). Liberalizationof entry in the financial services professions offers policymakers a venuethrough which to import financial sector expertise. Table 3: Appraisal, Actuarial, and Insolvency Professionals in Select Countries Appraisers Insolvency experts Actuaries Number Number Number per million per million per million Economy population Number population Number population Number Argentina — — 0.92 34 4.54 168 Australia — — 31.57 606 — — Austria — — 2.84 23 — — Belgium — — 0.68 7 — — Brazil 29.39 5,000 — — 2.40 408 Canada — — 34.89 1,071 — — Czech Rep. 535.37 5,500 1.56 16 — — China 10.64 13,420 0.01 8 0.01 8 Finland 28.96 150 — — 18.73 97 France 29.74 1,750 2.53 149 21.78 1,282 Germany 97.38 8,000 0.99 81 20.22 1,661 Hong Kong (China) 159.46 1,084 — — 29.27 199 Hungary — — 2.20 22 12.87 129 India 0.34 350 0.03 33 0.11 111 Indonesia 6,665 1,400 0.02 4 0.03 7 Israel — — 0.16 1 — — Italy — — 0.80 46 — — Japan 44.96 5,700 0.04 5 6.73 853 Korea, Rep. of 36.47 1,724 0.02 1 0.23 11 Lithuania 126.01 466 — — — — Malaysia 21.50 500 1.12 26 — — Mexico 30.62 3,000 0.02 2 1.95 191 New Zealand — — 49.86 191 — — Nigeria — — 0.03 4 — — Norway — — 2.00 9 — — Pakistan — — — — 0.10 14 Philippines — — 0.01 1 0.90 68 Poland 77.62 3,000 0.28 11 0.10 4 Romania — — 0.62 14 — — Russia 27.48 4,000 — — — — Singapore 129.17 519 2.74 11 20.41 82 South Africa — — 7.13 305 — — Spain — — 0.30 12 — — Sweden 56.38 500 1.58 14 27.74 246 xli
  40. 40. Corporate Restructuring: Lessons from Experience Table 3: Appraisal, Actuarial, and Insolvency Professionals in Select Countries (cont’d) Appraisers Insolvency experts Actuaries Number Number Number per million per million per million Economy population Number population Number population Number Switzerland — — 0.84 6 48.05 345 Thailand — — 0.13 8 0.21 13 United Kingdom 334.79 20,000 27.02 1,614 79.75 4,764 United States 284.14 80,000 6.54 1,841 53.16 14,968 — Not available. Source: For insolvency, membership database of the International Federation of Insolvency Professionals; for appraisers, the International Valuation Standards Committee; for actuaries, the International Actuarial Association. Table 4: Qualification Requirements of Insolvency Experts in Select Countries Country and field Qualification requirements Insolvency experts Canada Membership requirements in the Canadian Insolvency Practitioners Association (CIPA) include the association’s standards of admission, prescribed course of study, and passage of required examinations. In 1997 the National Insolvency Qualification Program was created to harmonize qualification requirements. New Zealand Government is opposed to occupational registration, so there is no registration of insolvency practitioners. The following cannot qualify for appointment: persons under 18 years of age and creditors, shareholders, directors, auditors, or receivers of the company. Switzerland Insolvency is not a specialized profession. Activities are performed mostly by other specialized professions (lawyers, accountants). United Kingdom Insolvency experts are licensed and regulated by one of eight recognized professional bodies (for example, the Institute of Chartered Accountants in England and Wales plus the Secretary of State for Industry). Actuaries Argentina Examinations, university courses Brazil University degree program Finland Examinations of other bodies, government examinations Germany Examinations, university courses Hungary University degree plus 18 months of practice India Own examinations Japan Own examinations of other bodies Mexico University degree program Singapore Examinations of other bodies, university degree program Sweden University degree program University degree plus at least three years of qualified professional experience, in line with inter- Switzerland national guidelines of ASTIN (International Actuarial Association) United Kingdom Examinations, university courses United States Own examinations of other bodies Source: International Actuarial Association.xlii
  41. 41. IntroductionFinancial Engineering:Financial and Operational RestructuringCountries should avoid easy solutions, such as interest and principal forbear-ance and stretching the maturity of debt, while ignoring corporate opera-tional and financial restructuring. Such measures create moral hazard withfar-reaching implications. Financial stabilization and financial restructuringshould only buy time for more fundamental financial restructuring (thedilution of equity and sale of new equity) and operational restructuring (forexample, changes in management and major assets sales). The crisis coun-tries have used various techniques to address corporate restructuring.Asset Management CompaniesPresident Yang of China’s Huarong Asset Management Company has said,“Nonperforming loans are like an ice cream cone. If you don’t get rid ofthem, they melt all over your hands, and you don’t have anything left to sell.The key issue for the seller is the price it is willing to accept today to avoidthe wait and the commitment of resources required for potential collection.”Asset management companies should focus on rapid disposition. Their suc-cess is contingent on good governance and policies, transparency, purchaseof loans at market prices, and the realization of losses prior to purchase. The history of government-established and -managed asset managementcompanies does not inspire confidence. Mexico’s Bank Savings ProtectionFund (FOBAPROA), for example, has witnessed massive disappearance ofassets as well as failure to identify assets due to inadequate documentation.The resolution process has been extremely slow. Turkey’s asset manage-ment company is still unable to quantify the stock of assets that it holds.The Indonesian Bank Restructuring Agency (IBRA) has only disposed of asmall percentage of its holdings. By contrast, there have only been isolatedsuccess stories: Danaharta in Malaysia is the leading success, and the KoreaAsset Management Corporation (KAMCO) has been successful to a lesserextent. Danaharta’s success can be attributed to three key elements. It was givensubstantial up-front government funding, which provided leeway for opera-tions and recognition of losses. It was established with a finite lifespan. Andperhaps most important, it was founded not with a pool of permanent gov-ernment staff but rather with staff taken on secondment from the private xliii