Resolving Financial Distress by Way of a Contract: An Empirical Study of Small UK Companies

Abstract

This paper provides an empirical study of the resolution of financial distress in England. The study is based upon a unique data set of 532 financially distressed UK companies, most of which are small and privately held. The data were assembled from the private records of three major commercial banks. The main focus of our investigation is a description and analysis of the process of rescue and the extent to which it leads to turnaround or insolvency.

We find that the typical firm in our sample has a capital structure that is dominated by one senior lender (a bank) and dispersed trade creditors. The bank's loan is highly collateralised, it holds all the liquidation rights and controls the rescue process. Notwithstanding, we find an elaborate rescue process that contradicts claims that such a capital structure would lead to virtual automatic liquidation. Also, we find little evidence of co-ordination failures, especially among dispersed trade creditors. The paper provides strong evidence of how a contract driven bankruptcy procedure, with highly collateralised loans, will perform.

Keywords: Bankruptcy

JEL Classification: G24, G31, G32, G33