market folly

Today we wanted to highlight a paper by Wei Jiang, Kai Li, and Wei Wang, entitled "Hedge Funds and Chapter 11" found via The American Finance Association, Publishers of the Journal of Finance.

The abstract of the paper reads as follows:

"This paper studies the presence of hedge funds in the Chapter 11 process and their effects on bankruptcy  outcomes. Hedge funds strategically choose positions in the capital structure where their actions could have a  bigger impact on value.  Their presence, especially as unsecured creditors, helps balance power between the  debtor and secured creditors. Their effect on the debtor manifests in higher probabilities of the latter’s loss of  exclusive rights to file reorganization plans, CEO turnover, and adoptions of KERP, while their effect on secured  creditors manifests in higher probabilities of emergence and payoffs to junior claims."


The paper finds that some of the biggest players in Chapter 11 are household names: Oaktree Capital, Appaloosa Management, Apollo Advisors, Cerberus Capital Management, and Silver Point Capital, among others.

And for those of you that might not have time to read an entire paper, it intriguingly concludes that:

"We find that hedge fund presence is associated with a higher probability of the debtor’s loss of  exclusive rights to file a reorganization plan, a higher probability of emergence, more favorable distributions to  the claims they invest in, greater CEO turnover, and more frequent adoptions of KERP.  We further establish the  causal effects of hedge funds, especially in their role as creditors, through instrumentation for hedge fund  participation.  Finally, we show that the favorable outcomes for claims in which hedge funds invest do not come  at the expense of other claimholders—they are more likely to result from value creation by alleviating financial  constraints and mitigating conflicts among different classes of claims."


Embedded below is the paper Hedge Funds and Chapter 11:




You can download a .pdf copy here.


For more on hedge funds and distressed investing, check out notes from Dan Loeb & Daniel Krueger's talk at a distressed investing panel as well as Marc Lasry's thoughts on distressed opportunities.