The Privatization of Bankruptcy: Evidence from Financial Distress in the Shipping Industry
We study the resolution of financial distress in shipping, where the ex-territorial nature of assets has distanced the industry from on-shore bankruptcy legislation. We demonstrate how contracts and private institutions have adapted to the industry’s special circumstances so as to deliver an effective resolution of financial distress.
We investigate three costs of distress: coordination failures leading to the arrest of ships, the direct costs of arrest and auction, and the fire sale discount. We find that most arrests are not caused by coordination failures but rather are precipitated by debtors whose equity is far out of the money and where the ships are close to their break up values. The direct costs of arrest and auction are 8% of a vessel’s value, and there is an average fire sale discount of 26%.
However, when we control for the low quality of such ships (due to under-maintenance), their low value, and corrupt versus non-corrupt ports, the discount is no more than about 5%. We find an equivalent under-maintenance effect in aircraft operated by airlines in Chapter 11 bankruptcy.
The results inform the debate about the need for mandatory bankruptcy laws that are justified by coordination failures between creditors and large fire sale discounts.