Business Continuity in Times of Distress: Debt Restructuring Agreements and Compositions with Creditors in Italy

Abstract

The Italian insolvency framework makes several restructuring tools available to firms and their creditors, so that distress does not necessarily lead to liquidation. This paper analyses two such instruments: debt restructuring agreements (DRAs) and compositions with creditors (CCs), both commonly used to reorganize distressed firms and preserve their continuity. These procedures typically involve large firms, particularly in the case of DRAs where judicial control over negotiations is milder. Firms using DRAs are in less critical economic conditions when they file for restructuring, but they do so after longer periods of distress. Despite their declared aim, the effectiveness of these instruments in terms of business continuity is limited: many firms that use them end up exiting the market, in particular in DRAs. Firms that survive display only partial recovery, which is relatively more intense in CCs. However, the apparently superior performance of CCs is overshadowed by the long duration of restructuring, which may prevent us from observing definitive outcomes.

The efficiency of preventive restructuring procedures: Evidence from France

“…Supporting distressed companies at all costs can lead to lost productivity growth and economic dynamism, as evidenced by Japan's stagnation during the “lost decade” (Caballero et al, 2008). These findings align with a parallel study conducted in Italy (Danovi et al, 2020), underscoring the imperative to bolster preventive restructuring measures and implement enhanced control systems. These steps are crucial to mitigate moral hazard risks stemming from company decisions, thereby optimizing the efficacy of such measures.…”

“…For consistency with previous research (Denis & Kimberly, 2007; Dallocchio, Ferri, et al, 2022), a 4‐year period following restructuring ( T = 4) is used to define success. Zombie firms are defined as companies with interest expense higher than EBIT, in linea with previous research (Danovi et al, 2020). On the contrary, a successful firm is one that has survived and achieved a positive return on assets, indicating that EBIT exceeds interest expense and the firm is not a zombie firm.…”

“…Also, in the Italian case it was found that after 1 year 94% of early restructuring measures were found to finish in a standard procedure or in a liquidation while this rate drop to 89% for standard restructuring measure. Similarly, Danovi et al (2020) explored Italian bankruptcy law and its primary restructuring tools and showed that firms, utilizing hybrid and preventive restructuring tools, although in less dire economic conditions when initiating restructuring, demonstrate lower survival rates compared to standard bankruptcy procedures firms upon procedure completion.…”

“…Moreover, the literature on financial restructuring and its relationship with firm performance has yielded mixed results. While theoretically, financial restructuring is expected to improve firm performance through increased profits and revenue, and a balance in terms of equity and debt funding leading to a reduction in finance costs and loss of capital, empirical studies have shown conflicting results (Danovi et al, 2020). Notwithstanding the lack of empirical evidence, the importance of early restructuring is recognized as a crucial factor in maximizing creditor value and minimizing economic cost.…”

“…The literature on preventive restructurings is limited but growing, with several recent studies examining the outcomes of firms undergoing restructuring in different contexts. Danovi et al (2020) focus on the Italian case and find that, counter‐intuitively, firms undergoing restructuring using debt restructuring agreements (DRAs) exhibit lower survival rates than those using judicial compositions with creditors (CCs), despite the former being undertaken by firms in better economic conditions and involving less court supervision. The authors suggest that the relatively limited frequency of debt write‐offs in DRAs may be partly responsible for this outcome.…”