The Choice between Informal and Formal Restructuring : The Case of French Banks Facing Distressed SMEs

This empirical paper investigates the path to the resolution of financial distress for a sample of small and medium French firms in default, in particular on the decision between bankruptcy and informal (out-of-court) negotiations. The procedure is depicted as a sequential game in which stakeholders first decide whether or not to engage in an informal negotiation. Then, conditional on opting for negotiations, the debtor and its creditors can succeed or fail in reaching a workout agreement in order to restructure the firm's capital structure. We test different hypotheses which captures the coordination vs. bargaining power issues, informational problems, firms' characteristics, and loan characteristics. Using a sequential LOGIT approach, we first find that the probability of an informal negotiation decreases when the bank is the debtor's main creditor and increases with the size of the loan and the proportion of long term debt. In addition, the likelihood of successfully reaching an informal agreement decreases when the management of a badly rated firm is considered as faulty and when the bank is the debtor's main creditor. Finally, we find no evidence for the impact of collateral on the resolution to financial distress