hedge strongfundsstrong and chapter 11 - columbia university.pdf

THE JOURNAL OF FINANCE • VOL. LXVII, NO. 2 • APRIL 2012 Hedge Funds and Chapter 11 WEI JIANG, KAI LI, and WEI WANG∗ ABSTRACT This paper studies the presence of hedge funds in the Chapter 11 process and their effects on bankruptcy outcomes. Hedge funds strategically choose positions in the capital structure where their actions could have a bigger impact on value. Their presence, especially as unsecured creditors, helps balance power between the debtor and secured creditors. Their effect on the debtor manifests in higher probabilities of the latter’s loss of exclusive rights to file reorganization plans, CEO turnover, and adoptions of key employee retention plan, while their effect on secured creditors manifests in higher probabilities of emergence and payoffs to junior claims. THIS PAPER EXAMINES THE roles of hedge funds in Chapter 11 and the effects of their presence on the nature and outcome of the bankruptcy process. Hedge funds’ participation in the bankruptcy process takes a variety of forms, includ- ing investing in debt claims, buying equity stakes, serving on the unsecured creditors or equity committee, and pursuing a “loan-to-own” strategy, whereby a hedge fund acquires the debt of a distressed borrower with the intention of converting the acquired position into a controlling equity stake upon the firm’s emergence from Chapter 11. Using a comprehensive sample of 474 Chapter 11 cases from 1996 to 2007 formed by merging a variety of data sources, we show that hedge fund presence ∗Jiang is with Columbia University, Li is with the University of British Columbia, and Wang is with Queens University. We thank our team of dedicated research assistants, Gregory Duggan, Sam Guo, Bobby Huang, and Greg Klochkoff. We also thank Lynn LoPucki at UCLA and Ben Schlafm