Privatesector P U B L I C P O L I C Y F O R T H E Note No. 200 November 1999 How to Accelerate Corporate and Financial Sector Restructuring in East Asia Stijn Claessens, Resolving systemic banking and corporate distress is not easy. The large scale of the East Asian Simeon financial crisis has made the task even more daunting in Indonesia, the Republic of Korea, Malaysia, Djankov, and Daniela and Thailand (figure 1). Two years into the process, bank and corporate restructuring is still a work in Klingebiel progress (Claessens, Djankov, and Klingebiel 1999). Governments should act to accelerate it. Besides adopting common policy reforms—improving financial regulation and supervision, corporate governance, and bankruptcy procedures—and shoring up banks’ capital positions, governments could take or facilitate three additional steps: FIGURE 1 THE EAST ASIAN CRISIS—LARGER THAN MANY Set up competitive, privately managed specialized funds, to hold nonperforming loans Indonesia and depoliticize restructuring. Allow auctions as an alternative to negotiations, to speed debt Korea, Rep. of restructuring. And allow employee ownership Malaysia participation schemes, to reduce workers’ Thailand resistance to changes in ownership. This Note Private sector claims reviews current approaches to financial Argentina, 1980–82 Nonperforming loans restructuring and explains the proposed Chile, 1981–83 Fiscal cost of crisis mechanisms for accelerating the process. Mexico, 1995–present Although governments have spent substantial Finland, 1991–94 sums to clean up balance sheets, banks remain inadequately capitalized in all four countries Japan, 1992–present (table 1). While Korean and Malaysian banks may be able to cover their capital shortfall from Sweden, 1990–93 retained earnings in a reasonable time, that is not 0 50 100 150 200 250 the case for banks in Indonesia and Thailand. But even in Korea and Malaysia letting banks fend for Percentage of GDP themselves will be risky. Self-recapitalization makes banks less willing to absorb losses and so Source: Claessens, Djankov, and Klingebiel 1999. hinders corporate restructuring. Because capital- constrained banks shift assets into government The World Bank Group ▪ Finance, Private Sector, and Infrastructur e Network 2 How to Accelerate Corporate and Financial Sector Restructuring in East Asia TABLE 1 FINANCIAL DISTRESS, STATE OWNERSHIP, AND THE PUBLIC DEBT BURDEN Percent Indicator Indonesia Republic of Korea Malaysia Thailand Current nonperforming loans in banks as a share of all financial assets (1999) 34.1 15.9 17.9 27.9 Large, distressed corporations restructured out of court (as of August 1999) 17 48a 32 29 Capital shortfall in banks as a share of GDP (1999) 12.7 10.7 5.5 15.4 Firms with debt servicing problems (2001, projected)b 52.9 17.2 13.8 22.3 Public debt (including financial restructuring costs) as a share of GDP (1999) 98.3 37 48 39.3 Interest payments on public debt as a share of fiscal revenue (1999) 91.8 14 6.5 6.5 Fiscal costs of crisis as a share of GDP (1998)c 50 26.5 16.4 32.8 a. Excludes companies affiliated with the five largest chaebol. Such companies are restructured through a separate mechanism. Including them would significantly reduce the share of restructured firms. b. Firms that cannot cover their interest payments from operating cash flows. The projection is based on actual mid-1999 corporate performance data and International Monetary Fund macroeconomic forecasts as of August 1999. c. Includes the fiscal cost of recapitalization and the expected extra fiscal costs. Source: Claessens, Djankov, and Klingebiel 1999. securities, it also limits corporate lending and FIGURE 2 STATE OWNERSHIP HAS RISEN SHARPLY thus impedes economic recovery. And an under- capitalized financial sector can inspire banks to State-controlled financial assets as a percentage of GDP finance risky but potentially high-return projects 150 in attempts to restore their capital. End-1996 August 1999 While corporate restructuring has accelerated, 120 corporate distress remains high and many cor- porations are unlikely to grow out of their prob- lems. Moreover, much financial restructuring appears cosmetic, with restructured loans often 90 reverting to nonperforming status. Even though operational corporate restructuring will take sev- eral more years, financial restructuring needs to 60 be done now—and in such a way as to ensure that deep operational restructuring will follow. 30 The costs of financial sector restructuring are high in the East Asian crisis countries—ranging from 16 to 50 percent of GDP—and are creating large fiscal burdens. If the governments absorb 0 Indonesia Republic of Korea Malaysia Thailand all these costs, public debt will rise sharply—in Indonesia to more than 90 percent of GDP, and Source: Claessens, Djankov, and Klingebiel 1999. in Korea, Malaysia, and Thailand to 37 to 48 per- cent. The large fiscal outlays have caused many The World Bank Group 3 BOX 1 USING ASSET MANAGEMENT COMPANIES TO RESOLVE BANKING CRISES—CROSS-COUNTRY EXPERIENCE Two main types of asset management companies can be dis- Rapid asset disposition vehicles fared somewhat better: tinguished: those set up to expedite corporate restructuring, two of four agencies, those in Spain and the United States, and those established as rapid asset disposition vehicles. A achieved their objectives. These successful cases suggest review of seven asset management companies (in Finland, that asset management companies can be effective, but only Ghana, Mexico, Spain, Sweden, the Philippines, and the for narrowly defined purposes of resolving insolvent and non- United States) reveals a mixed record. viable financial institutions and selling off their assets. But Two of the three companies set up for corporate restruc- specific conditions are required: assets that are easily liqui- turing failed to expedite restructuring, suggesting that asset dated (real estate), professional management, political inde- management companies are rarely good tools for this pur- pendence, skilled human resources, appropriate funding, pose. Only the Swedish asset management company man- adequate bankruptcy and foreclosure laws, good information aged its portfolio successfully, acting in some instances as management systems, and transparency in operations and lead agent in the restructuring. But it was aided by special processes. circumstances: the assets it acquired were mostly in real In Mexico and the Philippines the asset management com- estate, not manufacturing (which are harder to restructure), panies were doomed from the start by transfers of politically and they were a small fraction of the banking system’s assets motivated loans or fraudulent assets difficult for a government (making it easier to maintain independence from political agency susceptible to political pressure to resolve or sell. pressure and to sell assets back to the private sector). Both agencies failed to achieve their objectives. Source: Klingebiel forthcoming. observers to question the sustainability of pub- But durable economic recovery in the East Asian lic debt as interest payments threaten to take up economies will require more and deeper corpo- a large share of fiscal revenue. rate restructuring and improvements in the allocation of investable funds. Without sharply State ownership has increased sharply in the accelerated financial restructuring, the risk of a crisis-affected countries. Through support for downturn is high in some countries. weak financial institutions and acquisition of nonperforming loans by publicly owned asset Three strategies for financial management companies, the state now controls restructuring an average of about 100 percent of GDP in finan- cial assets, up from 45 percent before the crisis Three approaches to financial corporate restruc- (figure 2). Governments have had limited suc- turing can be distinguished. Countries can use a cess in selling off such assets: they have sold centralized, government-led approach by focus- only five banks, and asset management compa- ing asset recovery in one public agency, an asset nies have sold only 2 percent of corporate assets. management company (box 1). Centralizing assets may help consolidate skills and resources The countries have made some progress in pol- and ease the monitoring and supervision of icy reform, but much remains to be done. workout practices. As claims are consolidated, Financial sector regulations—such as loan clas- leverage over debtors may be increased and per- sification and provisioning guidelines—still trail verse links between banks and corporations bro- international best practice, and the rules for deal- ken, allowing better collection of loans. Yet an ing with weak financial institutions (a factor con- asset management company holding a large tributing to the crisis) need further tightening. share of corporate claims is difficult to insulate Improvements are needed in the governance from political pressures. Moreover, transferring structures of banks and corporations to ensure loans breaks the links between banks and that resources are used most productively. And corporations—links made valuable by banks’ bankruptcy and reorganization procedures need privileged access to corporate information. And further strengthening and streamlining. if an asset management company fails to actively 4 How to Accelerate Corporate and Financial Sector Restructuring in East Asia FIGURE 3 CONCENTRATION OF OWNERSHIP AFFECTS EASE OF CORPORATE AND FINANCIAL SECTOR RESTRUCTURING Japan BANKS OTHER FINANCIAL INSTITUTIONS 44% 28% Other financial 15 largest institutions families 51% Banks 7% 24% 13% 8% 30% 15 largest Government 26% 12% families 13% Owners Banks Corporations Government 3% Corporations 15 largest families 25% 15 largest families Government 16% Other financial institutions CORPORATIONS Republic of Korea BANKS OTHER FINANCIAL INSTITUTIONS Other financial Banks 15% 14% institutions 19% 17% Government 15 largest 15 largest 12% Government families families 38% 18% 45% 10% 9% 6% 12% Government 8% Owners Corporations 8% Banks Corporations 15 largest 15 largest families families 69% Government Other financial institutions CORPORATIONS Note: Percentages refer to relative shares of concentrated control. Concentrated control refers to owners with stakes of more than 5 percent. Source: Claessens, Djankov, and Klingebiel 1999. The World Bank Group 5 manage the assets it holds, it can undermine Asia are warehousing assets or trying to restructure credit discipline in the entire financial system. corporations rather than pursuing their main objective, disposing of assets; this is much like the The decentralized, creditor-led workout ap- experience in developing countries. Many of the proach relies on banks and other creditors to prerequisites for successful asset management resolve nonperforming loans. Since banks know companies are missing in East Asia; for example, the borrowers, and since their own survival many of the assets transferred are corporate, not depends on asset recovery, they may be better real estate assets, which tend to be easier to restruc- able and more willing than asset management ture. In addition, the large state ownership stake companies to maximize recovery value and has made restructuring susceptible to political inter- avoid future losses. Furthermore, banks can pro- ference. And the state can hardly be expected to vide new loans during debt restructuring. force through corporate restructuring measures that would lead to large layoffs. To be successful, however, decentralized debt workouts require limited or no ownership links The decentralized approach suffers in many East between banks and corporations (since other- Asian countries from ownership links between wise the same party would be both debtor and banks and corporations, weakly capitalized creditor), adequately capitalized banks, and banks, and disincentives to deep restructuring. proper incentives for banks and borrowers. The In Korea the many relationships between enti- slow pace of restructuring in Japan is due in part ties has hampered the resolution of financial dis- to the extensive ownership links between banks, tress for corporations and financial institutions other financial intermediaries, and corporations (see figure 3). Such relationships are also preva- (figure 3). The heavy cross-ownership led to a lent in Malaysia and Thailand. deadlock of claims that took a long time to break. Decentralized debt workouts also require that Despite several rounds of recapitalization, banks banks be adequately capitalized, so that they in all four crisis countries remain undercapitalized have the loss absorption capacity needed to because of their nonperforming loan portfolios. engage in corporate restructuring. Allowing Coordination problems among creditors remain banks to recapitalize through increased earnings large, delaying restructuring. Furthermore, many over a long time horizon (through implicit or creditors are weakly capitalized (Indonesia, explicit forbearance) limits their ability to engage Thailand) or face poor incentives (many banks in in rapid corporate restructuring. Korea are government owned, and banks in Thailand have extensive links with corporations). Finally, countries can adopt restructuring strate- Moreover, it is questionable whether banks will gies predicated on the recovery of economic be strong enough relative to corporations. activity and growth. This approach relies on fis- Because of the social and political consequences cal stimulus and external demand to increase of enterprise restructuring, and “too big to fail” growth and thereby lessen the need for corpo- arguments, banks may be unable to hold their rate and financial restructuring. own, especially against the large conglomerates in Korea. The record in East Asia Finally, the incentive framework in which banks Most East Asian crisis economies are pursuing a and corporations operate remains weak. Rules mix of the three approaches. Indonesia, Korea, and for loan loss provisions, loan classification crite- Malaysia have transferred large amounts of non- ria, and disclosure still allow banks to carry non- performing loans to asset management companies. performing loans. And bankruptcy systems are But this centralized approach has yet to show much too weak to force borrowers to come to the table success. Most asset management companies in East with good restructuring proposals. 6 How to Accelerate Corporate and Financial Sector Restructuring in East Asia BOX 2 JAPAN ’ S APPROACH TO RESOLVING ITS BANKING CRISIS — COSTLY AND DRAWN OUT The Japanese banking problem started in the late 1980s, when in early 1998 did the government pass emergency measures, deregulation allowed large corporations to switch from bank making more public funds available, creating a framework to to capital market financing, eroding banks’ profitability. resolve banking problems, requiring banks to recognize bad Having lost their low-risk customers, and aided by lax regula- loans, and removing tax barriers to workouts. tion and extensive deposit guarantees, banks aggressively Corporate restructuring. For much of this period financial expanded into real estate (which rose from 15 to 35 percent of institutions with weak capital positions avoided making loan total lending in 1970–88). Fueled by bank funds, real estate and loss provisions or writing off loans and did not force corporate stock markets expanded rapidly until 1990, when the collapse restructuring. Moreover, they lacked many of the tools for deal- of real estate and equity prices turned many loans nonperform- ing with debt restructuring expeditiously (including insolvency ing and reduced banks’ capital positions. laws). Their usual practice was to stretch out maturities and Financial sector restructuring. The government was slow carry loans indefinitely. The web of relationships between core to address the problem in any comprehensive way. In 1992 it shareholders and main customers ensured that aggressive col- relied on assisted mergers and explicit forbearance to cope lection efforts remained rare. Very low interest rates reduced with bank losses, hoping for quick recovery of the economy the costs of carrying nonperforming loans, which continued to and the real estate market. As small financial institutions be concealed. Existing corporate management generally and savings and loan companies showed signs of acute remained in place, no matter how inefficient, and nonviable cor- distress—partly as a result of gambling to recover losses— porations even received new money. the government followed with a ten-year “rehabilitation” Only recently have large firms, having faced massive plan, predicated on a recovery of land prices. But land prices losses in 1998, started significant efforts to restructure, while failed to recover, and nonperforming loans continued to grow temporary special loan guarantees have given small firms in size and number. some breathing room. As a result of banks’ improved capital The government tried a new approach in 1994–95. It closed positions and stronger accounting rules and regulations, some credit cooperatives and savings and loan companies. It bank-led informal reorganizations have also picked up also created an asset management company, which ended up recently. While these are encouraging signs, many reforms warehousing the assets of failed credit cooperatives rather remain to be undertaken, including overhauling the bank- than disposing of them. Facing growing international pres- ruptcy codes. sures, the government introduced legislative reforms, limited Hopes for recovery pinned on growth. Following the col- the operations of weak financial institutions, and strength- lapse of the asset price bubble in 1990, Japan’s GDP growth ened the deposit insurance scheme. But it left accounting averaged only 1.5 percent a year, compared with 4.5 percent rules and the supervisory framework unchanged. during the previous decade. The authorities’ strategy for The government continued to expect that banks could banking sector recovery was predicated on a resumption of grow out of their problems by widening their interest spreads, growth that would restore banks and borrowers to financial thus taxing depositors and borrowers for the recapitalization strength. Yet despite large and repeated fiscal stimulus pack- costs. But several more banks failed, prompting the govern- ages (which boosted gross public debt from 70 percent of ment to extend an unlimited guarantee on all deposits in 1996. GDP in 1990 to 120 percent in 1999) and a loose monetary pol- In 1997 several prominent securities companies failed, requir- icy (with overnight rates at 0 percent), durable growth has yet ing significant liquidity support from the Bank of Japan. Only to occur. Source: International Monetary Fund 1998. The World Bank Group 7 To speed restructuring, countries are trying to ability to repay. Bank regulators may need to enhance the decentralized approach, including evaluate all rules, regulations, and policy state- by making out-of-court systems more demand- ments to ensure that they facilitate rather than ing. But such steps may not suffice, and some hinder restructuring by: can create their own risks. Thailand, for exam- ▪ Allowing partial debt forgiveness. ple, is encouraging banks to set up private asset ▪ Permitting immediate debt writeoff for tax pur- management companies, some managed by poses. independent advisers. But private asset man- ▪ Providing banks flexibility in valuing pay- agement companies can be a mixed blessing. ments in kind and tax relief on such payments. Transferring loans to an asset management com- ▪ Eliminating artificial ceilings on assets pany does nothing to strengthen banks’ capital acquired by financial institutions through position, and it can allow banks to hide losses restructuring. by using above-market prices for the loans. ▪ Eliminating unnecessary taxes, duties, and levies on shares issued as a result of debt-to- The resurgence of growth now under way in equity conversions. some East Asian countries may fade once initial ▪ Eliminating all taxes on the issue or exchange inventory rebuilding and recovery of consumer of debt instruments used in debt restructuring. demand have run their course. And a combina- tion of high growth and continued low interest The difficulty of getting these preconditions in rates is unlikely when demand for investment place suggests that the existing financial restruc- funds rises again. The Japanese experience shows turing strategies being pursued by the East Asian that a growth-oriented strategy is risky when bank crisis economies are unlikely to bring deeper and corporate distress are systemic (box 2). financial restructuring and institutional reform. Moreover, the other barriers to achieving these Decentralized strategies are in principle more goals remain—the concentration of corporate sound than centralized ones, but the precondi- control in the hands of a few families, the strong tions for success are formidable. Governments political connections of these families, and the need to strengthen banks’ capital position and extensive links between banks, nonbank finan- tighten the overall incentive framework for cial institutions, and corporations. The risks are restructuring. One option to consider for strength- high of a stalemate and a situation similar to that ening banks’ capital position is ex post rather than in Japan—where banks continue to carry non- ex ante recapitalization. Recapitalizing banks ex performing loans and corporations delay ante does not ensure that restructuring will take needed structural adjustments while the govern- place, and it creates considerable moral hazard. ment tries and fails to reinvigorate growth A bank’s recapitalization could instead be linked through fiscal stimulus. to its progress in sound corporate debt restruc- turing. Even more explicit would be ex post Making growth last—three additional recapitalization under a sharing rule (recapitaliz- steps ing a bank with a certain percentage of the losses it incurs in corporate restructuring). East Asian governments need to consider three additional steps to accelerate and deepen the To put more bite in the incentive framework for restructuring process: restructuring, governments should tighten pro- ▪ Specialized investment funds to break the links visioning and classification rules for bank loans. between interested parties. That means requiring financial institutions to ▪ An auction process to deal with the nonper- apply them uniformly to standard, restructured, forming loans of small corporations. or rescheduled loans and ensuring that classifi- ▪ Employee ownership to reduce workers’ resis- cation is based on the borrower’s demonstrated tance to, and thus to accelerate, restructuring. 8 How to Accelerate Corporate and Financial Sector Restructuring in East Asia Specialized investment funds early in the restructuring process to help shape the deal and give the banks the advantage of Viable corporate financial restructuring will have investors’ specialized restructuring skills. to involve debt-equity swaps in which banks acquire shares of corporations. That puts a heavy A fund would participate directly in the workout burden on banks, which lack the technical process between banks and a corporation, nego- capacity to deal with large-scale restructuring of tiating as a potential equity investor in the restruc- corporations and corporate debt. If banks end tured corporation. It would take over part of the up holding the converted equity—which would corporation’s bank loans and swap claims for be necessary in some countries to ensure viable equity, leaving the banks to lengthen maturities corporations—they will become unstable and and provide some interest relief and working cap- more akin to mutual funds. ital. Banks would not engage in debt-equity swaps. To relieve banks of these problems and facilitate restructuring, a government could create a class Having the fund enter the negotiations at the of specialized investment funds. These could be same time as the banks would improve the privately managed (with a mix of domestic and prospects for viable restructuring deals, as the foreign management), venture capital–like fund would be under pressure to earn realistic, funds, possibly organized by industry, and risk-adjusted rates of return. It could also enhance established explicitly to buy nonperforming the banks’ negotiating power by making debt loans, restructure distressed assets, and manage relief and debt-equity swaps available at the same the converted equity. Equity shares already held time as debt restructuring and new money. by banks could also be transferred to them. The funds would be owned by the government, with Transfer prices and values would be determined financing possibly coming from the banks as in negotiations between the banks and the fund well. Their managers would work under perfor- in competition with other funds and other mance contracts whose payout depends on the investors. The banks would be recapitalized by valuation of the assets under management at a the government based on a fixed portion (say, 75 final, future date (for example, three years percent) of their losses. This approach would thus away). link government support for bank recapitalization to explicit progress in corporate debt restructur- These funds would differ from most asset man- ing and make transparent the losses incurred by agement companies in three ways. First, they the banks in achieving the restructuring. would focus on corporate restructuring, includ- ing taking control of corporations when After an initial period the funds could be allowed warranted. Second, they would be managed by to trade shares in corporations with one another the private sector, with a mix of domestic and in an over-the-counter market. Later, shares of foreign management. Third, governments could the funds themselves could be traded. The struc- create several of these vehicles, which could ture of the funds, as privately managed but pub- then compete for the purchase of nonperform- licly owned entities, would allow assets to be ing loans from banks. recycled to the general public over time. One model for selling assets back to the public is the Competition and early involvement. The funds Hong Kong model of disposing assets acquired could compete in buying nonperforming assets during a period of market support. Another is from financial institutions and would provide for distribution to the general public of shares in the a transparent process of taking assets off banks’ funds; this would create a market for the funds balance sheets. To accelerate and deepen cor- that could provide signals for adjusting the per- porate restructuring, the funds would participate formance contracts of fund managers. The World Bank Group 9 FIGURE 4 BALANCE SHEETS BEFORE AND AFTER THE FUNDS BEFORE THE FUNDS AFTER THE FUNDS CORPORATION CORPORATION Assets Liabilities Assets Liabilities Assets 100 80 Bank loan Assets 70 35 Bank loan (true value 70) 20 Equity 10 Subordinated loan from fund 25 Equity from fund 100 100 70 70 BANK BANK Assets Liabilities Assets Liabilities Corporate loan 80 80 Deposits Corporate loan 35 80 Deposits (true value 70) 10 Equity Loan to fund 25 17.5 Equity from government Government bonds 10 (0 true value) Government bonds 27.5 Loss 10 90 90 97.5 97.5 FUND FUND Assets Liabilities Not established Subordinated loan 25 Loan from bank to corporation 10 10 Equity from government Equity in corporation 25 35 35 GOVERNMENT GOVERNMENT Assets Liabilities Assets Liabilities Equity in bank 10 10 Government bonds Equity in fund 10 27.5 Government bonds (true value 0) Equity in bank 17.5 (true value 10) 10 10 27.5 27.5 Source: Claessens, Djankov, and Klingebiel 1999. 10 How to Accelerate Corporate and Financial Sector Restructuring in East Asia The fund in action. Consider the following exam- Silanes 1999; and Hausch and Ramachandran ple. A corporation has US$80 in a bank loan but forthcoming). They may be well suited for a market value of assets (present value of salable crisis-affected countries, where bankruptcy assets or future cash flows) of US$70—and thus procedures are poorly developed. A market- a negative equity of US$10. As a consequence of based auction scheme would allow relatively the financial distress of its corporate borrower, the easy conversion of debt to equity while pre- state-owned bank is undercapitalized: it has an serving the firm’s value as a going concern. outstanding loan of US$80 that is worth US$70, Some variants of the scheme would leave the holds US$10 in government bonds, and has corporation in the hands of existing owners US$80 in deposit liabilities. Thus while its notional (and managers); others would transfer it to the equity is US$10, its true value is zero (figure 4). owner most capable of maximizing its value. Using auctions could avoid the wasteful nego- The fund now engages in three-party negotiations tiations and delays often encountered in bank- with the bank and the corporation, reaching a ruptcy procedures. debt restructuring agreement to be implemented in two steps. In the first step, to restore the cor- An auction is probably best suited for small poration to financial viability, the bank loan is debtors with few creditors where speed is essen- reduced to US$45, of which US$35 remains in the tial to preserve going-concern value and the costs form of a bank loan and US$10 is exchanged for of formal bankruptcy and reorganization are subordinated debt to the bank.1 The bank then large relative to the claims being restructured. swaps US$35 of the remaining debt for a US$25 equity stake in the corporation and writes off A complementary step to reduce employee US$10 by reporting a loss of this amount in its resistance profit and loss statement. Participation by employees and other stake- In the next step the fund swaps a loan of US$25 holders can help facilitate financial restructuring. for the bank’s US$25 equity stake, and US$10 in In a country moving from a pay-as-you-go pen- government bonds for the bank’s US$10 of sub- sion system to a more fully funded, privately ordinated debt. The liability side of the fund’s managed pension fund system, assets can be balance sheet shows a debt obligation of US$25 reprivatized by endowing the new private pen- to the bank and US$10 in equity owned by the sion funds with some of the assets after they are government. worked out by the private managers. Or corpo- rate assets can be swapped with employee The government then compensates the bank for retirement funds or accrued future staff benefit 75 percent of the writeoff of US$10 by injecting obligations. additional equity capital of US$7.5 in the form of government bonds. The government’s balance Employee participation has broad attraction. It sheet consequently shows a liability of US$27.5 reduces resistance to changes in ownership, (the US$10 in old bonds and US$17.5 in new). including foreign sales. It softens the fear of job And it shows assets of US$17.5 (old and new losses and can reduce the risk of conflict capital in the bank, whose true value is US$7.5) between labor unions and management. and US$10 (the initial equity stake in the fund). Employee ownership aids the formation of equity in the economy and can help reduce Auctions—another option for restructuring corporate debt. Where equity markets are corporate debt depressed, introducing or increasing the use of employee ownership schemes can increase the Auctions could also be used to facilitate debt demand for shares. These features are particu- restructuring (see La Porta and Lopez-de- larly appealing during financial distress, when The World Bank Group 11 conflicts of interest between management, own- Gilson, Stuart. 1995. “UAL Corporation.” Case Study 9-295-130. ers, and employees run high and external financ- Harvard Business School, Cambridge, Mass. Hausch, Donald B., and S. Ramachandran. Forthcoming. “Bankruptcy ing is hard to come by. In some countries Reorganization through Markets: Auction-Based Creditor Ordering governments may have to remove tax impedi- by Reducing Debts (ACCORD).” World Bank, East Asia and the ments to enable employee ownership plans. Pacific Region, Poverty Reduction and Economic Management Sector Unit, Washington, D.C. International Monetary Fund. 1998. “Japan: Selected Issues.” The financial crisis in Chile in the early 1980s is Washington, D.C. one situation in which multiple stakeholders Klingebiel, Daniela. Forthcoming. “The Use of Asset Management Companies in the Resolution of Banking Crises: Cross-Country were invited into the ownership of distressed Experiences.” Policy Research Working Paper. World Bank, firms. The crisis had led to the nationalization of Financial Sector Strategy and Policy, Washington, D.C. many financial institutions and corporations. La Porta, Rafael, and Florencio Lopez-de-Silanes. 1999. “Creditor Protection and Bankruptcy Law Reform.” Harvard University, The government undertook extensive financial Cambridge, Mass. reform and restructuring that involved reprivati- zation. Because the supply of private equity was limited, the government used innovative means Stijn Claessens, Simeon Djankov, and Daniela to sell off nationalized assets. One approach was Klingebiel, Financial Sector Strategy and Policy to set up funds to purchase assets of specific companies on behalf of the workers. The pur- chase price for the shares was raised through bank loans secured by the purchased assets and Viewpoint is an open the deposit of additional shares received by the forum intended to workers as compensation. Upon repayment of encourage dissemination of and the bank loans, the funds were dissolved and the debate on ideas, shares went directly to the workers. innovations, and best practices for expanding the private sector. The In the United States employee ownership plans views published in this have often been used in restructuring specific series are those of the firms. Up-front restructuring costs can be authors and should not be attributed to the reduced by granting employees equity owner- World Bank or any of its ship in exchange for wage concessions and affiliated organizations. sometimes job cuts. In a well-known example Nor do any of the conclusions represent United Airlines negotiated significant wage con- official policy of the cessions in return for a majority equity stake for World Bank or of its employees. By effectively communicating the Executive Directors or the countries they benefits of the restructuring to investors and represent. financial analysts, the company created addi- To order additional tional shareholder value, enhanced the restruc- copies please call turing effort, and gave the capital market a 202 458 1111 or contact Suzanne Smith, editor, positive view of its strategy (Gilson 1995). Room F11K-208, The World Bank, 1818 H Street, NW, Washington, 1 The exact amounts of debt reduction and new debt would be D.C. 20433, or Internet determined in the negotiations between the banks, borrower, and address ssmith7@ fund (or funds), possibly in competition with other investors. worldbank.org. The series is also available on-line References (www.worldbank. org/html/fpd/notes/). Claessens, Stijn, Simeon Djankov, and Daniela Klingebiel. 1999. “Financial Restructuring in East Asia: Halfway There?” Financial Printed on recycled Sector Discussion Paper 3. World Bank, Washington, D.C. paper.