Stakeholder losses in corporate restructuring: evidence from four cases in the North American steel industry - Case Study

Financial Management (Financial Management Association), Autumn, 1993 by Vijay M. Jog, Igor Kotlyar, Donald G. Tate

9. P.F. Drucker, "Corporate Takeovers -- What is to Be Done?," The Public Interest (Winter 1986), pp. 3-24.

10. K. Engelmann and B. Cornell, "Measuring Costs of Corporate Litigation: 5 Case Studies," Journal of Legal Studies (Vol. 25, No. 2, 1988), pp. 377-399.

11. J. Franks and W. Torous, "An Empirical Investigation of U.S. Firms in Reorganization," Journal of Finance (July 1989), pp. 747-769.

This paper analyzes four major cases of restructuring in the steel industry. The main purpose of the paper is to investigate the impact of restructurings or announcements bankruptcy on not only the shareholders' and debt-holders' wealth, but also on other stakeholders of the firm including other creditors, suppliers, labor, and government agencies. This broadening of the investigation beyond the impact of shareholders and bondholders is consistent with some of the recent work in the corporate restructuring literature which questions the disruption costs of hostile takeovers in relation to their social and private benefits.(1) In addition, wherever possible, the operating and financial performance of these firms during the period leading to, during, and following the restructuring process is also shown.

The four cases exemplify the restructuring issues in the steel industry which, at its peak, employed close to 550,000 and was considered to be one of the most important industries in North America. The steel industry has faced five major threats to its existence including the introduction of labor-saving technology, overseas imports, competition from substitute materials such as plastics, overall slow economic growth in the 1980s, and the emergence of superefficient mini-mills.

The four restructured companies analyzed in this study are Wheeling-Pittsburgh Wheeling-Pittsburgh Steel Corporation (WPSC), LTV Steel, Weirton Steel, and Algoma Steel.(2) WPSC (1985) and LTV (1986) represent cases where the firms filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code; Weirton (1984) represents an employee buyout using the employee stock ownership plan (ESOP) arrangement allowed under the United States Tax Code; where as whereas Algoma Steel (1991) represents a recent Canadian case where the company applied for protection under the Companies Creditors' Arrangement Act (Canada). In the latter two cases, the major players were the parent firms whose shareholders and debtholders indirectly suffered the losses incurred by these parent companies (the actual amount of these indirect losses could not be determined). As to their current status, WPSC emerged from Chapter 11 in 1991; Weirton and Algoma are operating under the ownership of their employees; at the time this paper was written, LTV was still under Chapter 11.(3) As a result of restructurings, the losses of all of the stakeholders of these four steel companies amounted to approximately $7 billion.

The paper is organized as follows. The first section provides a brief review of the empirical evidence on bankruptcy costs. This is followed by a brief summary of each case. The third section evaluates concessions and losses by each group of stakeholders and provides estimates of the direct bankruptcy costs associated with restructuring. The fourth section offers a view from another angle by examining contributions of each group to the restructuring process. Next, the financial and operating performance leading to, during, and, in one case, following the restructuring is presented. The paper ends with overall conclusions, identifying commonalities among the four restructuring cases.

It is important to point out that this paper was originally completed in June of 1992. Since then a number of events have taken place which are not accounted for in the paper. For example, in 1993, LTV successfully emerged from its Chapter 11 bankruptcy and prices of Algoma Finance shares have tripled. The authors feel that although these events would have an effect on some of the figures presented in this paper, they do not alter the main conclusions of the analysis.

I. Previous Empirical Evidence on Bankruptcy Costs

The existing literature on the empirical evidence of bankruptcy or restructuring costs can be roughly divided in two groupings.(4) The first group encompasses papers which analyze direct and indirect costs of a sample of bankruptcies. The estimates of direct costs, which include legal and administrative costs, are available, for example, in Altman |2~, Ang et al |4~, Warner |19~, and Weis |20~. These studies conclude that, as a proportion of the firm's total value or its equity value, these costs are in the order of two to five percent and are not very significant in comparison to the tax shield value of debt. The evidence on the more important indirect costs is available in Ahrony et al |1~, Altman |3~, White |21~, Clark and Weinstein |6~, Franks and Torous |11~.(5) Except for the last paper, the rest typically use either estimates of foregone sales and profits (Altman |2~) or cumulative average residual techniques to estimate the aggregate wealth loss suffered by the shareholders around the bankruptcy announcements. Some attempts are made to estimate losses suffered by debtholders as well (White |21~). Franks and Torous |11~ extend the evidence by a careful examination of the market value of securities received in a reorganization and compare them with the original value for 30 firms which emerged from Chapter 11 bankruptcies. Their analysis not only covers the wealth losses suffered by shareholders and debtholders but also by the unsecured debtholders and creditors. They conclude that, in many instances, the creditors bear a disproportional loss in these cases which results in favoring the shareholders.