Bank's Exposure and Private Workout Negotiations Between the Creditor Bank and the Debtor Company: An empirical study using event study methodology

Author Name AKIYOSHI Fumio  (The University of Tokyo Graduate School of Economics) /HIROSE Sumio  (Assistant Professor, Faculty of Economics, Shinshu University)
Creation Date/NO. April 2006 06-J-037
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In cases where a bank lends a huge amount of funds to a company, the bank is exposed to the higher risk of suffering serious financial loss in the event of the company's bankruptcy. Therefore, if the company actually faces serious financial distress, forcing it to enter into bankruptcy proceedings would put the bank itself in a financial crisis. Under the threat of suffering serious financial loss, bank managers are often reluctant to commence bankruptcy proceedings on these borrowers and to realize huge losses on their own banks' balance sheets. Instead, banks try to avoid explicit bankruptcy proceedings and keep these failing companies alive through various kinds of financial relief; for instance, providing forbearance loans and/or reducing debt burdens through a private workout proceeding to an extent insufficient to lead to the successful reorganization of the debtor but enough to help keep the debtor afloat for the time being. These practices may help bank managers maintain their positions. This sort of situation - where the creditor bank itself faces a crisis - may increase the bargaining power of the debtor company in private workout negotiations and the creditor bank may be obliged to compromise on terms unfavorable to the bank. This paper attempts to examine such a possibility by applying event study methodology to private workout cases with debt forgiveness. Sample events were identified by extracting newspaper reports that contained the keywords saiken hoki (debt waiver) and saimu menjo (debt forgiveness) and that appeared in four financial newspapers - Nihon Keizai Shimbun, Nikkei Sangyo Shimbun, Nikkei Ryutsu Shimbun and Nikkei Kinyu Shimbun - during the period from January 1993 - January 2004. Our findings show that in cases where the leading creditor bank's risk exposure to the debtor was high, the share price of the debtor company significantly increased and the share price of the main bank significantly decreased upon the debtor's request for debt relief including debt forgiveness. This indicates that the market was already anticipating that a debt relief agreement would be reached in a way favorable to the shareholders of the debtor company with portions of risks against additional financial loss transferred from the debtor to its leading creditor bank. Therefore, there is a possibility that the supervising authorities' straightforward approach - reinforced monitoring and stricter assessment of bank assets - is critical to the fundamental solution to the forbearance lending problem.