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In Rememberance: World Trade Center (WTC)

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Financial Distress and Bank Restructuring of Small to Medium Size UK Companies

by Julian Franks of London Business School & CEPR, and
Oren Sussman of Wadham College of the University of Oxford

Spring 2005

Abstract: We use a unique data set to study how U.K. banks deal with financially distressed small and medium-sized companies under a 'contractualist' bankruptcy system. Unlike in the U.S., these procedures limit the discretion of courts to strict enforcement of debt contracts, without any dilution of creditors' claims. We show that lenders and borrowers select a debt structure that avoids some of the market failures often attributed to a contractualist system. Collateral and liquidation rights are highly concentrated in the hands of the main bank, giving it a dominant position in restructuring or liquidating a defaulting firm. There is little litigation, and no evidence of co-ordination failures or creditors' runs. However, there is some evidence that the bank's dominance makes it 'lazy' in monitoring, relying heavily on the value of its collateral in timing the bankruptcy decision.

Published in: Review of Finance, Vol. 9, No. 1, (Spring 2005), pp. 65-96.

Previously titled: Resolving Financial Distress by way of a Contract: an Empirical Study of Small UK Companies

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