Provision of Management Incentives in BankruptFirms∗

Vidhan K. Goyal† Wei Wang‡

October 27, 2012

Abstract

We examine the use of key employee retention plans (KERPs) in bankrupt firms.We find that creditor control of bankruptcies is associated with a greater likelihoodof bankrupt firms offering retention and incentive bonuses to managers. Retentionbonus plans are also more common when there is a greater risk of employee turnover.We find that incentives provided under such plans improve bankruptcy outcomesfor creditors along several dimensions: they increase the likelihood of emergence,reduce bankruptcy duration, and result in fewer violations of the absolute priorityrule. Our results do not support the common view that retention bonus plans enrichmanagers at the expense of creditors.

JEL classification: G30, G32

Keywords: Key employee retention plans; KERP; Chapter 11; compensation; re-tention bonuses; creditor control; incentive bonuses

∗We acknowledge the helpful comments of Wei Jiang, Ken Lehn, Frank Li, Angie Low, Adair Morse,Paul Oyer, Jano Zabojnik and workshop participants at Concordia University, Hong Kong University,Monash University, Nanyang Technological University, National Chengchi University, Queen’s University,Singapore Management University, Yuan Ze University, and conference participants at the 2012 NorthernFinance Association annual meetings and the Seventh Annual Conference on Empirical Legal Studies atStanford Law School. We thank Wenhan Lin, Matt Murphy, Remya Neela, and Nikhil Wadhwa forexcellent research assistance, and Lynn LoPucki, Parcels Inc., and National Archives at various locationsfor their help with data collection. Vidhan Goyal thanks the Research Grants Council for financialsupport (RGC Project #641110). Wei Wang thanks the CA Queen’s Center for Governance for financialsupport. c© 2012 by Vidhan K. Goyal and Wei Wang. All rights reserved.†The Hong Kong University of Science and Technology, Clear Water Bay, Kowloon, Hong Kong,

E-mail: goyal@ust.hk‡Queen’s School of Business, Queen’s University, Kingston, Ontario, Canada, K7L 3N6, E-mail:

wwang@business.queensu.ca

“The bankruptcy court has become a place where corporate executives go toget permission to line their pockets and break their promise to workers andretirees.”

– Senator Edward Kennedy1

1 Introduction

Bankrupt firms often pay retention and incentive bonuses to their key employees to per-

suade them to stay with the firm through the restructuring process. Worldcom Inc., for

example, filed for bankruptcy in July 2002 and offered 329 of its key employees retention

bonuses that paid between 35% to 65% of their annual salary. Half of this bonus was paid

if the employees under the plan remained with the company for at least 5 months. The

remaining amount was payable 60 days after confirming a plan of reorganization.

Retention bonus plans are commonly viewed as schemes through which managers

enrich themselves. Critics claim that retention bonuses reward failed and entrenched

managers. For example, testifying before the U.S. Senate Committee on the Judiciary,

David McCall, a director with the United Steel Workers of America, characterized reten-

tion bonuses as corporate abuse and argued that KERPs are “golden parachutes payable

to executives of a reorganizing company and rewarding them handsomely, often after they

have cut workers’ pay reduced or eliminated retiree benefits, shuttered plants, and sold

them off . . . When workers learn of a KERP or massive fee award [paid to professionals],

it puts our bankruptcy system in a bad light and often makes the difficult choices required

in bankruptcy even harder to achieve.”2

1Statement of Senator Edward Kennedy to U.S. Congress (151 Congress Record S1990, March 3,2005). Congress eventually introduced provisions in the ‘Bankruptcy Abuse Prevention and ConsumerProtection Act of 2005’ (BAPCPA), provisions which made it difficult for companies in Chapter 11 topay retention bonuses.

2Statement of David McCall to the Senate Committee on the Judiciary on “Bankruptcy Reform” onFebruary 10, 2005. Media has also taken a negative view on retention bonus. See, for example, “Want

1

Defending these bonuses, companies have taken the position that retention plans pre-

vent critical employees from leaving when they are most needed. Management departures

in distressed firms are very common. Such departures are highly disruptive to the success-

ful and expeditious resolution of bankruptcy, as they result in a loss of continuity and high

search and training costs. As a result, the costs incurred through delays in bankruptcy

resolution and management changes could often be far greater than the cost of “pay-to-

stay” bonuses to key employees. According to firms using these plans, retention bonuses

are an efficient contracting solution to the problem of high turnover in bankrupt firms.

To examine the two starkly different views – the rent extraction view and the efficient

contracting view – we assembled a comprehensive database of key employee retention

plans (KERPs) at large public firms that filed for Chapter 11 between 1996-2007. This

database provides us with a first detailed look at the structure of retention and incentive

bonus plans in bankrupt firms.

Of the 417 firms in the sample, 39% adopt KERPs. Most plans offer retention bonuses

tied to a minimum stay of, on average, 9 months. The plans cover about 2% of the

firm’s employees and pay bonuses that are between 30 and 70% of their base salaries.

About half of these plans offer additional incentives tied to the resolution of bankruptcy

(either through emergence from bankruptcy or sale of assets), speed of restructuring,

debt recovery, and specific targets based on financial performance at plan confirmation.3

Some Extra Cash? File for Chapter 11 - ‘Pay to Stay’ Bonuses Are Common at Busted Tech Firms” byAnn Davis in the Wall Street Journal, October 31, 2001; “Bankruptcy-Law Overhaul Has Wriggle Room- Limits Set on Key Executives’ Pay, But Door Is Wide Open on Bonuses Linked to Achieving CertainGoals” by Nathan Koppel and Paul Davies in the Wall Street Journal, March 27, 2006; “$8.9M for Brass;Zip for Laid-off Staff - Canwest Secures Bonuses for Top Officials Despite Bankruptcy Filing” by MartinCash in the Winnipeg Free Press, October 24, 2009; “The CEO Bankruptcy Bonus” by Mike Spectorand Tom McGinty in the Wall Street Journal, January 27, 2012; “Testing Chapter 11 Limits” by RachelFeintzeig and Jacqueline Palank in the Wall Street Journal, August 19, 2012.

3The passage of BAPCPA in 2005 led to a precipitous decline in retention bonus plans and many firmscompletely switched to offering incentive bonus plans.

2

A reading of these plans suggests that incentives provided by bankrupt firms closely tie

bonuses to creditors’ claims and bankruptcy outcomes.

One of the key findings of our paper is that retention and incentive bonuses are common

in bankrupt firms that exhibit a large amount of creditor control. Specifically, bankrupt

firms with an approved creditors committee and with debtor-in-possession financing more

often pay retention and incentive bonuses. This evidence is consistent with senior-secured

lenders exerting control over bonus plans through loan documents in debtor-in-possession

financing while other unsecured lenders acting through a creditors’ committee.4

KERPs are also more common among bankruptcies in which there is a greater like-

lihood of employee turnover. Employees are more likely to change jobs when there are

many other potential employers in the same industry located in the same geographical

area as the Chapter 11 firm. We find that KERPs are more frequently adopted by firms

headquartered in such areas. In addition, KERPs are more frequently observed in in-

dustries in which senior executives benefit from greater growth in cash compensation. In

such industries, KERPs reduce the threat of employee turnover resulting from large pay

disparities at the bankrupt firm. Finally, firms in distressed industries exhibit a lower

likelihood of adopting these bonus plans presumably because there are fewer outside job

opportunities in such industries.

The only CEO characteristic that appears to be important in explaining CEO partic-

ipation in bonus plans is whether or not the CEO is a newly-hired turnaround specialist.

Such CEOs are more frequently paid retention bonuses. None of the other CEO charac-

teristics appears to matter. Moreover, governance variables have no predictive ability in

4Similarly, Eckbo et al. (2012) show that creditors are actively involved in CEO replacement decisionsand in designing the compensation of existing and new CEOs.

3

determining CEO participation in these bonus plans. Overall, there is no evidence that

“entrenched” CEOs initiate these plans to pay themselves large bonuses.

We further examine the effect of KERPs on bankruptcy outcomes. We distinguish

between KERPs that are retention-only plans from those that provide incentive bonuses

(with or without retention bonuses). The retention-only plans pay bonuses contingent on

a minimum stay or stay until plan confirmation and do not include an incentive component

tied to specific outcomes. In our tests, we use employees’ outside job options to identify

exogenous variation in the use of bonus plans.

While retention-only bonus plans do not materially improve outcomes for creditors,

KERPs that include incentive bonuses significantly improve outcomes. The likelihood

of a firm’s emergence from bankruptcy is greater when key employees are paid incentive

bonuses. Importantly, the outcome depends on the specific nature of incentives in these

plans. When key employees are offered bonuses that are tied to firm reorganization or

firm performance upon reorganization, firms are more likely to reorganize. By contrast,

when employees are paid bonuses tied to asset sale, firms are more likely to liquidate.

Furthermore, incentive bonuses affect both the duration of bankruptcy and deviations

from the absolute priority rule (APR). Firms that provide incentive bonuses spend sig-

nificantly less time in bankruptcy and exhibit a significantly lower likelihood of deviating

from the APR. This last result shows that provisions of incentive bonuses significantly

reduced shareholders’ ability to extract concessions from creditors. Overall, the findings

suggest that incentive plans improve outcomes for creditors by aligning managers’ inter-

ests with those of creditors, shortening bankruptcy duration, and limiting stockholders’

ability to extract concessions from creditors.

4

Relative to KERPs, standard compensation contracts are less relevant, perhaps even

suboptimal, when the fiduciary obligations of managers shift towards creditors as creditors

take control of the bankruptcy process. The results of the paper show that incentives

provided to executives of bankrupt firms become more closely aligned with the interests

of creditors. More broadly, the paper examines whether managers control the pay-setting

process in bankrupt firms, where agency problems are likely to be more severe. We

find no evidence consistent with the rent extraction view. In fact, our results suggest

that retention and incentive bonuses in bankrupt firms are the outcome of an optimal

contracting process. Finally, the fact that bankrupt firms provide retention and incentive

bonuses to key employees at all levels of corporate hierarchy suggests that the restructuring

of troubled companies requires more decentralized decision-making.

The paper is organized as follows. Section 2 provides a review of the literature on

CEO compensation in bankrupt firms and a review of our hypotheses. Section 3 describes

our data sources and the construction of key variables, and provides a summary of the

key features of retention and incentive bonus plans. Section 4 employs logit regressions to

predict the use of KERPs in bankrupt firms. Section 5 provides results from regressions

that examine the effect of KERPs on bankruptcy outcomes. Section 6 concludes the

paper.

2 Background

In a standard principal-agent framework, firms design compensation contracts to align the

interests of managers with those of stockholders. However, when firms become insolvent,

the fiduciary duties of managers shift from stockholders to creditors. How do incentive

structures evolve for firms in distress? What determines the payment of retention bonuses

5

in bankruptcies? How do bonus payments affect bankruptcy outcomes? This paper

explores these questions.

Much of what we know about the compensation of managers in distressed firms comes

from Gilson and Vetsuypens (1993), who examine the compensation policies of 77 publicly-

traded firms that filed for bankruptcy or privately restructured their debt between 1981

and 1987. Gilson and Vetsuypens found that CEOs in these firms suffer large personal

losses. Importantly, their results highlight the fact that firms often rely on compensation

policy to deal with financial distress. About 20% of firms in Gilson and Vetsuypens’ sam-

ple based their CEO’s compensation on the outcome of the firm’s financial restructuring.

In about 17% of the cases, bonuses were tied to a minimum length of stay with the firm,

and in another 10% of the cases, compensation plans were restructured to increase the

interdependence of the wealth of the CEO and that of creditors.

Two relatively recent papers also examine the compensation of CEOs in bankruptcy.

Henderson (2007) examines 76 large bankruptcies between 1992-2003 and finds that the

compensation of CEOs does not significantly change during distress situations. On the

contrary, Kang and Mitnik (2009) examine 99 bankruptcies over the 1992 to 2005 period

and arrive at the opposite conclusion. Specifically, they find that the CEOs of distressed

firms experience a significant reduction in their overall compensation, and that much of

this reduction is due to the decreased value of new grants of stock options.

This paper is unique in that it examines the retention and incentive bonus payments

offered to a larger group of employees identified as critical or key employees. The payment

of bonuses to key employees via KERPs grew in popularity in the early 2000s. Skeel (2003)

and Ayotte and Morrison (2009) argue that the increasing trend in the use of KERPs in

bankruptcies coincides with greater creditor control. Creditors are becoming increasingly

active in bankruptcies and are often instrumental in CEO replacement decisions and in

6

determining the design and structure of senior executives’ compensation. Eckbo et al.

(2012) find that creditor control is directly responsible for CEOs’ personal losses from

bankruptcy.

The changing nature of the bankruptcy process has significantly affected bankruptcy

outcomes. For example, Bharath et al. (2010) show that the increasing use of debtor-

in-possession financing and key employee retention plans are associated with a declining

trend in APR deviations. While we find similar results with respect to the use of KERPs

and APR deviations, our focus is on understanding the use of KERPs in bankrupt firms

and in examining the effects of KERPs on a number of other bankruptcy outcomes.5

What role do creditors play in a firm’s decision to offer retention bonuses to its key

employees? If retention bonuses are a symptom of agency conflicts between managers and

creditors, greater creditor control should result in fewer instances of retention bonuses to

managers. However, if retention bonuses are offered as part of creditors’ value-maximizing

strategy, creditor control should increase the likelihood of KERP adoptions. The two

views also yield different predictions regarding how KERPs affect bankruptcy outcomes.

If KERPs align employee incentives with those of creditors, creditor outcomes should

improve with KERPs. Thus, KERPs should influence reorganization versus liquidation

decisions, time spent in bankruptcy, and absolute priority deviations.

The controversy surrounding retention bonuses led Congress to amend the U.S.

bankruptcy law in 2005. The new legislation – known as the Bankruptcy Abuse Pre-

vention and Consumer Protection Act of 2005 (BAPCPA) – introduced section 503(c)

5In a related paper, Crutchely and Yost (2008) examine KERP programs and show that firm sizeincreases the likelihood of KERPs. They also show that firms with KERPs spend longer in bankruptcy.Since KERPs are adopted in large and complex bankruptcies, it is unclear if KERPs actually causebankruptcy duration to increase. We deal with such endogeneity issues by examining employees’ outsideoptions as instruments and find that incentive plans result in a quicker restructuring process, althoughretention plans do not. Our study covers a larger sample of bankruptcies and a longer period in examiningwhy firms adopt KERPs and the effect that such plans have on bankruptcy outcomes.

7

into the Bankruptcy Code: “a bankruptcy court is not to authorize payments to an ‘in-

sider’ for the purposes of inducing the person to stay with the debtor unless the court

determines that (a) he or she has a bona fide job offer from another company at the same

or higher compensation, (b) the individual provides services that are essential to the sur-

vival of the business, and (c) the retention payment is less than 10 times the average

compensation of a similar kind given to nonmanagement employees during the calendar

year”.

The new rules have dramatically changed the bonus plans offered by bankrupt firms

since 2005. As we will show later, BAPCPA resulted in retention plans becoming less

common while incentive plans gained popularity. In these performance-based pay plans,

firms offer bonuses which are contingent on their achieving a predetermined milestone.

These milestones are typically related to bankruptcy outcomes (reorganization versus

liquidation), speed of reorganization, debt recoveries, EBITDA, and enterprise value at

emergence. Bonus plans that are intended to provide incentive compensation to manage-

ment employees are subject to a more liberal review process under Bankruptcy Code 363.

Given the new legislation restricting the payment of retention bonuses, it has become even

more important to distinguish retention plans from those that provide incentive bonuses

in improving creditor outcomes.

3 Data Sources and Sample Description

3.1 Data

The present study begins with a sample of all Chapter 11 bankruptcy filings included

in the UCLA-LoPucki Bankruptcy Research Database (BRD) during the period from

8

1996 to 2007. The 497 Chapter 11 filings in the UCLA-LoPucki database include the

bankruptcies of all public firms with reported assets in excess of $100 million (in 1980

constant dollars) as of the last Form 10-K filed with the SEC pre-bankruptcy petition.

The filings are cross-checked with New Generation Research’s BankruptcyData.com to

verify their Chapter 11 status. Filings that were dismissed by the court (11 cases), cases

still pending as of December 31, 2008 (12 cases), financial firms (37 cases), utilities (11

cases), and firms headquartered outside of the U.S. (9 cases) are excluded.6 The resulting

sample of 417 firms in Chapter 11 is matched to Compustat in order to obtain firm-

level financial data. If information is missing in Compustat, it is filled in manually using

information from 10-Ks (obtained from EDGAR).

We identify firms with KERPs through a search of Bankruptcydata.com, 8-K filings,

reorganization/liquidation plans, and Factiva News Retrieval, using keywords that are

related to the use of retention and incentive bonus plans.7 The court documents re-

lated to KERP approvals are obtained from bankruptcy courts (specifically, through their

respective Public Access to Court Electronic Records (PACER) websites).8 The court

documents provide detailed information on KERPs, including the identity of the key em-

ployees to be covered, the purpose of the retention program, bonus amounts, and other

plan details.

6Financial firms and utilities are excluded because of differences in regulations and accounting stan-dards for these industries. Firms headquartered outside the U.S. are excluded because we require infor-mation on other firms located around the headquarter of the Chapter 11, and such location informationis only available for U.S. firms. Of the nine firms headquartered outside the U.S., one is in Argentina,two are in Canada, and another six are in Bermuda.

7The keywords that we use include “retention plan”, “bonus plan”, “incentive plan”, “retentionbonus”, “pay-to-stay”, “bankruptcy pay”, “managerial incentive”, “key employee”, “KERP”, “KEIP”,“KMIP”, and “KECP”.

8Every bankruptcy court maintains a PACER website, which contains the docket sheet for abankruptcy case. KERP motions and approvals for Chapter 11 firms are obtained through PACERin about two-thirds of the cases. For another 30% of the cases, we retrieve motions and orders directlyfrom U.S. bankruptcy courts, National Archives, and Parcels, Inc. For the remaining 4% of the cases, wecollect as much information as possible from company filings with SEC and news articles.

9

The Bankruptcy Research Database and Bankruptcydata.com are our primary sources

for basic information about bankruptcy filings, including the type of filing, the outcome of

the Chapter 11 process, and the months spent in restructuring. Bankruptcydata.com also

provides reorganization and liquidation plans with information on the classes of claims,

the dollar amount of allowed claims, recovery, and whether cash or security was given

to each class of claimant. In the event that a plan is not available in this database, we

obtain the information from the relevant 8-K filings or purchase the reorganization plans

directly from U.S. bankruptcy courts. Information about debtor-in-possession financing

and top management turnover is obtained mainly from Bankruptcydata.com, PACER,

and Factiva/LexisNexis. The institutional ownership data are obtained from 13F filings

provided by the Thomson Reuters Ownership Database.

We identify CEOs at the time of KERP approval and determine the CEO’s founder

status, age, and tenure from proxy statements and 10-K filings. We further determine

whether the CEO is an incumbent or newly hired. Newly-hired CEOs are defined as

those who are hired during a period starting three years before Chapter 11 filing and

ending with KERP approval. In cases of CEO changes, we determine whether new CEOs

are internal promotions or external hires. Through a perusal of news articles around

CEO appointments, we also identify whether or not the newly-hired CEO is a turnaround

specialist. The governance variables (including board size and the fraction of independent

directors) are collected from the firm’s last 10-K or proxy statements before bankruptcy

filing.

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3.2 Summary Statistics

Table 1 provides an annual distribution of firms adopting KERPs. Column (1) provides

an annual distribution of all Chapter 11 filings in our sample. Consistent with the well-

known relation between business cycles and financial distress, we observe a clustering of

bankruptcies in the early 2000s, a period that coincides with the U.S. recession. Column

(2) provides a distribution of firms using KERPs. About 39% of Chapter 11 firms in

our sample adopt KERPs. Consistent with the trends reported in Skeel (2003), Bharath

et al. (2010), and Jiang et al. (2012), we find that KERPs are more common in the recent

period; in the mid-to-late 1990s, less than one-third of the Chapter 11 firms adopt KERPs,

yet this number increases to over 50% in the later part of the sample period.

We classify KERPs into those which offer only retention bonuses, those which offer

both retention and incentive bonuses, and those which offer only incentives bonuses. Re-

tention bonuses are a common feature of the bonus plans adopted by firms in bankruptcy.

Among firms with KERPs, approximately 88% offer retention bonuses. In about half of

these cases, firms additionally pay incentive bonuses. There is a dramatic decline in the

use of retention bonus plans after 2005, which coincides with the enactment of BAPCPA.

As described in Section 2, BAPCPA placed severe restrictions on the payment of retention

bonuses which, in turn, resulted in an almost complete shift wherein firms developed a

preference for incentive bonuses over retention bonuses.

Panel A of Table 2 provides mean and median values of firm characteristics in the

pre-filing year. The sample firms are large, with average assets of $2 billion (in constant

2008 dollars) and a median asset value of $0.7 billion. The large sizes of bankrupt firms

in the sample are unsurprising, as BRD includes only large filings. Chapter 11 firms are

substantially overlevered, as one would expect; their average total liabilities to assets ra-

11

tio is 1.02 (the median is 0.92). The industry-adjusted leverage is 0.44, which indicates

significant distress.9 Firms are not only overlevered; they are also unprofitable. The

average industry-adjusted operating performance (measured as earnings before interest,

taxes, depreciation and amortization (EBITDA), scaled by assets, and adjusted for in-

dustry performance) is -0.07 (the median is -0.05). Secured debt represents about 42% of

assets. Institutions own about 27% of the firm’s stock at the time of filing.

Panel B reports descriptive statistics on bankruptcy filings. About 29% of the Chapter

11 filings are prepackaged bankruptcies in which reorganization plans are negotiated and

voted on by shareholders and creditors before bankruptcy filing. The simultaneous filing

of both the bankruptcy petition and the reorganization plan considerably shortens the

time that companies spend in bankruptcy.10 About 67% of the bankrupt firms obtain

debtor-in-possession financing. Roughly 44% of the bankruptcies are filed in Delaware.

Creditors’ committees are common; about 85% of firms have such committees approved

by court. By contrast, equity committees are less common and exist in only 11% of

bankruptcy cases.

The priority of claims is sometimes violated in Chapter 11 bankruptcy when a junior

claimant (which is often equity) receives some payment even though senior claimants are

not paid in full. Many bankruptcy scholars argue that deviation from APR happens be-

cause Chapter 11 is debtor-friendly, resulting in shareholders (or the managers supporting

them) having a significant ability to impose costs on creditors through tactics designed to

9We obtain the industry-adjusted characteristic by subtracting the median-industry characteristic(based on the two-digit SIC code) from the comparable characteristic for each firm.

10Tashjian et al. (1996) provide descriptive information on a sample of 49 prepackaged Chapter 11bankruptcies. They show that prepackaged bankruptcies incur lower direct cost of bankruptcy, resultin higher debt recoveries than traditional Chapter 11 filings, and the distressed firms spend less time inbankruptcy.

12

delay the resolution of bankruptcy. These tactics are costly to creditors and, as a result,

senior claimants sometimes agree to accept less than the contractual value of their claims.

To estimate the APR deviation, we obtain information about the type and amount of

new securities various claimant classes receive in the final reorganization plan approved

by court. The recovery to each class is estimated by adding up the values of cash and new

securities each class receives. Except for debt (for which we use the face value) other secu-

rities are valued using traded prices that most accurately post date the firm’s emergence

from bankruptcy. These traded prices are obtained from various sources, including CRSP,

Bloomberg, Datastream, and the Bankruptcy DataSource. An APR deviation is deemed

to have occurred if equity holders receive a payment before other senior claims are paid

in full.11 We use this information about APR deviation to construct an indicator variable

that takes a value of one if there is any APR deviation, and a value of zero otherwise.

APR deviations are not commonplace and occur in about 17% of bankruptcy cases. The

literature shows that APR deviations were much more common in the 1980s and in the

1990s (see Weiss (1990) and Adler et al. (2006)). Our observation of the decline in APR

violations is consistent with the findings of Bharath et al. (2010).

Panel C shows the mean and the median of the three governance variables and CEO

characteristics at the time that KERPs are adopted. The average board has 7 members,

71% of which are classified as independent directors. In about half of the cases, the CEO

is also the chairman of the board. Founder-CEOs are present in 15% of the cases. CEOs

are, on average, 53 years old and have worked in their current position for about 4 years.

Consistent with the substantial turnover commonly observed in distressed firms, only

about 41% of the CEOs are incumbent (i.e., they have not been replaced in the last three

11See, for example, Eberhart et al. (1990), Betker (1995), and Jiang et al. (2012).

13

years before Chapter 11 filing). A little more than half of the new CEOs are external

hires. About 20% (48 of 239) of the new hires are turnaround specialists.

Panel D provides a distribution of Chapter 11 outcomes. An outcome is classified as a

reorganization if there is evidence that the firm has reorganized and emerged from Chapter

11 status. Similarly, an outcome is classified as a liquidation if the firm’s assets are sold

piece-meal, and as an acquisition if all of the firm’s assets are acquired by another firm.

Firms reorganize and emerge from Chapter 11 in about 60% of the cases. Liquidations

happen in about 29% of the cases and the remaining 11% of the firms are acquired. The

last two columns of Panel D provide the mean and median time spent in bankruptcy,

measured as the number of months between the filing date and the confirmation date of

the plan. Across all cases, the average duration from the month of filing bankruptcy to

reorganization, acquisition, or liquidation is about 17 months (the median is 13.5 months).

The average duration of bankruptcy decreases from 21 months at the beginning of our

sample period to 12 months in the more recent 2004-2006 period. The decrease in average

bankruptcy duration is also evident in the literature. Frank and Torous (1994) report

an average duration of 30 months during the 1983 to 1988 period; Bharath et al. (2010)

report an average duration of 18 months for the more recent period. Firms that reorganize

spend less time in bankruptcy than firms that are liquidated or acquired.

Table 3 provides summary statistics of KERPs. The average plan covers about 2%

of the firm’s employees. The employees are classified into three tiers: the highest tier

consists of a few top managers being paid larger bonuses, while the lowest tier consists of a

greater number of managers being paid smaller bonuses. In the highest tier, a median of 6

employees receive retention bonuses that represent about 75% of their salaries. Conversely,

in the lowest tier, a median of 46 employees receive retention bonuses that represent about

30% of their salaries.

14

Incentive bonuses are offered to even fewer employees; a mere 1% of the employees

receive them. The employees covered by incentive plans are similarly divided into three

tiers. CEOs are included in about 80% of these plans. The plans almost always include

other senior managers (99% of retention plans and 95% of incentive plans include non-

CEO executives). Other mid-level employees are also included frequently.

About 85% of retention plans tie retention bonuses to a minimum-stay (i.e., a firm

pays a bonus if the executive stays with the firm for a pre-determined period). The typical

plan requires managers to stay for at least 9 months following the KERP initiation date

in order to qualify for bonuses. About 52% of retention plans promise additional bonuses

tied to stay till plan confirmation.

In 97 of the 417 Chapter 11 filings (or 23%), key employees’ compensation is explicitly

tied to the resolution of the firm’s bankruptcy and/or other outcomes directly affecting

payoffs to creditors. By comparison, far fewer firms tied executive compensation to cred-

itor’s wealth in the 1980s (Gilson and Vetsuypens, 1993). A large proportion of KERPs

make incentive bonus payments contingent on bankruptcy resolution (78%). Roughly

48% of these plans offer bonuses contingent on the firm’s emergence from Chapter 11 and

another 30% pay bonuses upon the sale of assets or the firm’s liquidation. Incentive plans

that offer bonuses that are tied to EBITDA and enterprise value targets are also common.

Less common are incentive plans that tie employee payments to the speed of restructuring

or to debt recovery (about 13% of the incentive bonus plans include these features).

The overall cost of the average plan is about $8.5 million for retention bonuses and

about $7 million for incentive bonuses. The maximum financial pool allocated for bonus

plans averages about $9 million for retention plans and $16 million for incentive plans.

These plan costs, representing about 0.4% of pre-filing assets, appear small when com-

pared to professional legal fees paid in bankruptcy, which, according to LoPucki and Do-

15

herty (2004), could be as large as 2% (in a sample of 48 large public company bankruptcies

from 1998 to mid-2002).

4 Explaining the Use of KERPs in Chapter 11

4.1 Logit Results

We begin by examining the relation between creditor control and KERP adoption. Ay-

otte and Morrison (2009) suggest that creditors, in the most recent decade, have come to

dominate the Chapter 11 process. If bonus plans benefit creditors, then the greater influ-

ence of creditors in Chapter 11 should result in the more frequent adoption of KERPs.

We employ two measures of creditor power: (a) the presence of a creditors’ committee,

and (b) the presence of debtor-in-possession financing. The existence of a creditors’ com-

mittee indicates that unsecured creditors have an influence on bankruptcy restructuring.

According to Henderson (2007), creditors’ committees are often involved in negotiating

employment agreements and determining managerial pay. Jiang et al. (2012) show that

the managers of hedge funds often seek representation on a creditors’ committee to influ-

ence bankruptcy process. The active role of creditors in bankruptcies suggests that they

are likely to reject bonus packages that do not improve creditor outcomes.

We use debtor-in-possession (DIP) financing as our second measure of creditor control,

as Skeel (2004) argues that DIP financing has become a new tool of governance in Chapter

11. Through DIP financing, creditors gain a significant amount of control through loan

agreements and subsequently exert control over the restructuring decisions of bankrupt

firms.

16

Table 4 presents results from logit regressions where the dependent variable takes a

value of one if the firm adopted a KERP and zero otherwise. The results show that both

measures of creditor control have the predicted positive relation with KERPs and both

are statistically significant. The strong positive coefficients on the presence of creditors

committee and the DIP financing suggest that greater creditor control is associated with

a higher likelihood of key employee retention plans in Chapter 11. The estimates suggest

that the probability of KERP adoption is 34% higher in firms with a creditor’s committee

than those without such a committee, keeping all other variables at their means. Similarly,

the probability of KERP adoption is 24% higher in firms that receive DIP financing

compared to those that do not.

In Column (2), we additionally include variables that measure employees’ outside job

opportunities. Firms facing a greater threat of employee turnover are more likely to adopt

KERPs. Previous research shows that bankruptcies result in a significant increase in CEO

turnover. This should also be correlated with high turnover among non-CEO executives.12

If firms optimally adopt retention plans to induce employees to stay with the firm, then

they are more likely when there is a greater threat of employees leaving the firm.

Whether employees switch firms or not depends on the ease with which they can find

alternative employment. Geographic considerations are important because managers find

moving disruptive and costly (Almazan et al., 2007). With many potential employers in

a local market, employees have fewer concerns about the loss of earnings from leaving

their current firm. Consistent with this argument, Kim (2011) finds that wage losses are

greater in labor markets with fewer potential employers in the local industry.

Following Lazear (2009), we label employment markets where there are many

same-industry firms in the same geographic area as thick employment markets

12Fee and Hadlock (2004) show that non-CEO turnovers are elevated around CEO dismissals.

17

(ThickEmplMarkets). In the context of such markets, managers enjoy greater job op-

portunities, and suffer smaller wage losses from switching employers while bankrupt firms

find it more difficult to retain employees unless they provide explicit “pay-to-stay” or

incentive bonuses. The variable ThickEmplMarkets takes a value of one if there are at

least twenty other firms in the same two-digit industry within a 100-kilometer radius from

the sample firm’s headquarter.13 Alternative cutoffs, based on both the number of firms

and the size of the geographic area, yield similar results. The positive and statistically

significant coefficient for the ThickEmplMarkets variable is consistent with the argument

that the availability of alternative job options increases retention bonus payments. The

effects are also economically large. The probability of KERP adoption is 33% higher for

bankrupt firms operating in thick employment markets than for firms not operating in

such markets.

As another proxy for employees’ propensity to change jobs, we include the median

industry cash compensation growth (IndCompGrowth).14 A higher growth in cash com-

pensation in comparable firms implies greater pay disparities between the pay of execu-

tives at the bankrupt firm and the pay of those at comparable firms. Consistent with our

prediction, we find that a higher cash compensation growth in the median industry firm

positively affects the likelihood of KERP adoption. A one standard deviation increase in

median industry cash compensation growth increases the probability of KERP adoption

by about 6%.

13The distance of a company’s headquarter to all other Compustat firm headquarters is estimated usingthe Haversine formula. See http://en.wikipedia.org/wiki/Great-circle distance.

14We focus on cash compensation rather than total compensation because equity-based compensationis less relevant for firms in bankruptcy. Cash compensation is tied much more closely to short-termperformance targets. For example, Yahoo’s 2012 proxy statement states that their annual cash bonus“is intended to focus on, and reward the achievement of short-term goals that are important to theCompany.” Cash compensation is estimated as the average salary and bonus payments for the top-five paid non-CEO executives. We use firms in Execucomp to calculate the annual growth rate of cashcompensation of senior executives for all 2-digit SIC industries (excluding the firm in question).

18

Yet another proxy for employee outside job options is whether the industry is in

distress. Fewer jobs are available in distressed industries. As such, the presence of such

industry-wide distress reduces a firm’s incentives to offer retention bonuses. We follow

Acharya et al. (2007) in classifying an industry as distressed if the industry median stock

return for the year before the Chapter 11 filing is -30% or less. The coefficient for the

distressed industry dummy is negative, although its significance level is weak (p=0.11).

The results suggest that firms operating in distressed industries have a marginally lower

likelihood of using KERPs.

In Columns (3) to (5) we add the three governance variables: the fraction of indepen-

dent directors, CEO-chairman duality, and board size. If KERP adoption is a reflection

of agency problems we should observe that firms with weaker boards and powerful CEOs

have a higher likelihood of adopting KERPs. We find no such evidence. Both the fraction

of independent directors and CEO-Chairman duality variables are insignificant. Only the

board size variable carries a positive sign and is statistically significant at the 5% level.

The board size variable does not have a unique interpretation. Larger boards could be

a proxy for greater firm complexity, which, in turn, could explains why firms with larger

boards are more likely to adopt KERPs.15

The regression specifications control for firm size, the pre-packaged bankruptcy indi-

cator, the Delaware filing indicator, and industry-fixed effects.16 We find that firm size

significantly affects the propensity of a firm to adopt KERPs. A one standard deviation

change in firm size increases the likelihood of KERP adoption by 10% (with all other

variables held at their means). The positive relation between firm size and the likelihood

15The board literature shows that complex firms have larger boards. See, for example, Coles et al.(2008) and Lehn et al. (2009).

16In unreported tables, we find that bankruptcies are relatively more common in manufacturing,telecommunications, and in wholesale and retail industries while they are less common in oil and gas,chemical, and healthcare industries.

19

of KERP adoption has two alternative interpretations. If firm size is a proxy for agency

problems, then one could infer that managers of large firms boost their wealth by paying

themselves retention bonuses. However, firm size could also be a proxy for bankruptcy

complexity, where this complexity increases the demand for management continuity.

The coefficient for the pre-packaged filing indicator is negative and statistically sig-

nificant at the 1% level. The estimates suggest that firms opting for pre-packaged

bankruptcies have an 18% lower likelihood of KERP adoption than those sticking to

regular bankruptcies. The pre-packaged nature of these filings means that plans are pre-

negotiated to include less flexibility for managers. Thus, in these cases, there are fewer

incentives to provide retention and incentive bonuses. The coefficient for the Delaware

dummy is statistically insignificant.

In Table 5, we extend these results to a multinomial logit framework that examines a

firm’s decision to offer retention-only bonuses separately from its decision to offer incentive

bonuses (with or without retention bonuses). The results from these additional tests are

generally consistent with those presented above. Overall, we find that firms are more

likely to adopt both types of plans where there is a creditors’ committee and where lenders

provide DIP financing. The results show that creditors’ committees more strongly predict

the adoption of retention-only plans, while the presence of DIP lenders more strongly

predicts plans with incentive bonuses. While ThickEmplMarkets positively predicts

adoption of both types of plans, the other two measures of employees’ outside options

only affect the plans with incentives. Another difference between the results in this table

and those in Table 4 is that board size does not affect the likelihood of adoption of

retention-only plans, whereas it positively affects the adoption of plans with incentive

bonuses.

20

4.2 Explaining Plan Features

Table 6 presents Tobit estimates from regressions that relate bonus plan features to var-

ious firm and bankruptcy characteristics. These regressions examine whether or not the

firm and bankruptcy characteristics explain the size of these plans along a number of

dimensions, including the fraction of key employees covered in the bonus pool, the size

of the bonus paid to the highest tier, and plan costs as a fraction of pre-filing assets.17

Columns (1) to (4) present results for retention bonuses, while columns (5) to (8) present

results for incentive bonuses.

The results show that larger firms include more employees in the plan, offer bonuses

which are a larger fraction of employees’ salaries, and commit more financial resources (as

a fraction of assets) to the plan. The pre-packaged plans, on the other hand, offer smaller

bonuses and commit a smaller fraction of their assets to the bonus pool.

Both DIP financing and the presence of creditors’ committees result in a larger per-

centage of employees receiving retention bonuses and the bonuses at such firms are a

larger fraction of their assets. In other words, greater creditor control increases retention

plan costs. However, the effects documented for incentive bonuses in Columns (5) to (8)

suggest that creditor control has no effect on incentive bonus amounts and plan costs.

ThickEmplMarkets positively affect the plan sizes and plan costs for the payment of

retention bonuses but not for incentive bonuses. On the other hand, IndCompGrowth

positively affects plan sizes and costs for incentive bonuses but not for retention bonuses.

17The motions and orders for KERP adoption provide either target percentage bonus or the dollarvalue paid to key employees. We use the percentage value directly if it is quoted in court documents. Ifthe documents provide dollar amounts, we convert them to a percentage by dividing the bonus amountsby CEO salary in the last fiscal year before Chapter 11 filing. The percentage bonus paid to top tierexecutives in our sample ranges between 4 percent and 200 percent for retention plans, and between 7percent and 844 percent for incentive plans, respectively.

21

4.3 CEO Participation in KERPs

We examine CEO participation in KERPs to test if “failed and entrenched” CEOs use

retention bonus plans for self-serving purposes. If the use of KERPs reflects agency prob-

lems, then we would expect to see that entrenched top executives are a part of retention

plans. Furthermore, weak governance will make it more likely that CEOs participate.

However, if KERPs are an equilibrium response to contracting problems in bankruptcy,

we expect to see no relation between CEO characteristics, governance, and CEO partici-

pation in KERPs.

Table 7 presents logit estimates predicting CEO participation. In columns (1) to (4),

we examine CEO participation in all KERPs regardless of whether they are retention-only

plans, or plans with both retention and incentive features, or plans with just incentive

bonuses. Thus, in these columns, the dependent variable takes a value of one if the CEO

participates in a KERP, and is zero otherwise. In columns (6) to (8), we focus on CEO

participation in plans with incentive bonuses to examine if the effect differs when we

exclude retention-only bonus plans. Here, the dependent variable takes a value of one if

the CEO receives incentive bonuses, and is zero otherwise.

The independent variables include various CEO characteristics: CEO age, CEO

tenure, CEO founder status, and the dummy variable for an incumbent CEO. In the

specification reported in column (2), we consider CEOs who are promoted internally and

those who are hired externally, and CEOs who are turnaround specialists. Additional

specifications include governance variables and firm characteristics.

The results reported in Table 7 show that, of all CEO characteristics, only turnaround

specialists have a higher likelihood of receiving retention bonuses. However, turnaround

specialists are not any more likely to receive incentive bonuses (as seen from estimates in

22

Columns (5) to (8)). This reflects the importance of retaining turnaround specialists to

the distressed firms that hire them. There is also some evidence that old managers are

less likely to be included in incentive bonus plans.

Overall, the findings are contrary to the media perception that KERPs are used to

enrich failed managers. Among the governance variables, only board size predicts CEO

participation in KERPs. Once again, it is not clear if governance is weak in firms with

bigger boards. Greater board size most likely reflects bankruptcy complexity, and bonuses

to CEOs in such cases may be optimal from a creditor’s perspective. Other than the

board size variables, creditor control measures are the only measures that are statistically

significant in these regressions. The results suggest that greater creditor control increases

the likelihood that CEOs are covered by KERPs.

Overall, our inability to explain the inclusion of CEOs in the bonus plans as a func-

tion of CEO characteristics and governance suggests that firms make optimal decisions

regarding CEO participation in KERPs.

5 KERPs and Bankruptcy Outcomes

In the previous section, we show that creditor control has predictive power for KERP

adoptions by bankrupt firms. This raises the question of whether or not KERPs im-

prove bankruptcy outcomes for creditors. Estimating the effect of KERPs on outcomes is

not straightforward, since firms optimally determine when to use bonus plans. A firm’s

decision regarding the use of KERP can be specified as a function of the X variables

below.

23

KERP ∗i = Xiβ + εi (1)

Firms adopt KERPs if Xiβ + εi is positive.

KERPi =

1 if KERP ∗

i > 0,

0 if KERP ∗i ≤ 0

(2)

The bankruptcy outcome is a function of the Z variables and whether or not the firm

has adopted a KERP.

Outcomei = Ziγ + µKERPi + ηi (3)

The outcome variables we focus on include bankruptcy resolution (emergence ver-

sus liquidation), time spent in bankruptcy, and deviation from APR. Econometrically,

a selection problem amounts to a non-zero correlation between the error disturbances

in equations (1) and (3). To identify the outcome models, we rely on two instrumental

variables that predict the adoption of KERPs but not bankruptcy outcomes. Both of

our instruments are related to employees’ outside options. We know from Section 4 that

KERPs are adopted more frequently in bankrupt firms with greater employment options

for employees (measured by ThickEmplMarkets). We do not expect a geographic con-

centration of same-industry firms to affect bankruptcy outcomes directly except through

their influence on KERP adoption. Our second instrument is the median industry cash

compensation growth (IndCompGrowth), which affects the propensity of employees to

change jobs because of an increasing wage gap between the bankrupt firm and its peers.

Our results reported in Section 4 suggest that a higher growth in industry cash compen-

24

sation increases the likelihood of KERP adoption. However, with this variable, there is

a concern that industry cash compensation growth may be correlated with industry out-

comes which may somehow affect bankruptcy outcomes. Thus, in discussing our results,

we place a greater emphasis on our first instrumental variable (ThickEmplMarkets) than

the second.

The Zi variables include firm size, leverage, profitability, the prepackaged bankruptcy

indicator, Delaware-bankruptcy indicator, the industry-in-distress indicator, the secured

debt scaled by assets, and variables measuring creditor control. All of these variables are

known to affect the likelihood of emergence from bankruptcy (Lemmon et al., 2009; Jiang

et al., 2012). In the regressions, the Xi variables contain the two instrumental variables

in addition to a full overlap with Zi variables.

With binary-outcome variables and binary-endogenous explanatory variables, the ap-

propriate estimation method is a bivariate probit model (see Woolridge (2002 Chapter

15.7.3)). With continuous-outcome variables, the appropriate estimation method is a

treatment regression model (see Maddala (1983)). All of the models are estimated using

the maximum-likelihood estimation method. In Columns (1) to (3) of Table 8, we ex-

amine the effect of KERPs on the bankruptcy outcomes. However, KERPs include both

retention-only plans and plans that provide incentive bonuses. Since incentive bonus plans

more directly tie the bonuses to outcomes, we expect the effect of incentive bonus plans on

outcomes to be stronger. We, therefore, examine the effect of plans that include incentive

bonus plans on outcomes in Columns (4) to (6).

25

5.1 KERPs and Bankruptcy Outcomes

Column (1) presents result from bivariate probit regressions that explain the likelihood of

a firm’s emergence from bankruptcy. The dependent variable is an indicator variable that

takes a value of one if the firm reorganizes and zero if the firm liquidates or is acquired.

The predictions on how bonus plans affect the likelihood of bankruptcy reorganization

are complex and nuanced. KERPs provide retention bonuses that compensate managers

to stay at the firm until a specified date (or until plan confirmation). In many bankrupt-

cies, creditors prefer the firm to reorganize. But in others, creditors prefer the firm to

liquidate. There are no clear predictions on how the provision of pay-to-stay bonuses will

affect emergence since in both reorganizations and liquidations, creditors will want key

employees to stay at the firm until the bankruptcy is resolved. The results in column

(1) show no relation between the existence of bonus plans and the probability of a firm’s

emergence.

In column (2), we present the treatment regression results that examine the effect

of KERPs on the duration of bankruptcy. Bankruptcy costs are a function of the time

spent in bankruptcy. Thus, we expect creditors to be sensitive to, and invested in, the

expeditious resolution of bankruptcy.18 The question we pursue here is whether or not

KERPs affect the duration of bankruptcy.

Retention plans that pay bonuses contingent on managers’ staying for a minimum

length of time should have no effect on bankruptcy duration. However, retention plans

that pay bonuses at plan confirmation should provide incentives for managers to speed

up bankruptcy (assuming that managers have positive discount rates). However, the

results show no significant relation between KERPs and bankruptcy duration. While

18LoPucki and Doherty (2004) provide estimates suggesting that doubling the time a case remainspending increases fees by about 57%.

26

the coefficient estimate on KERP adoption is negative, it is statistically indistinguishable

from zero.

The results in Section 4 show that greater creditor control is associated with an in-

creased use of KERPs. In light of these findings, a logical question to ask is whether or

not the use of KERPs reduces the ability of shareholders to obtain payoffs from creditors

(as evidenced in APR deviations). Furthermore, Bharath et al. (2010) recently show that

APR deviations have been declining since the early 1990s. Bharath et al. attribute this

decline to increasing creditor control in bankruptcies, since an increase in creditor control

coincides with an increase in DIP financing and the adoption of key employee retention

plans. The increase in DIP financing and KERPs during the 1990s is also documented by

Skeel (2003).

In Column (3), we examine the extent to which KERPs mitigate absolute priority

deviations. If bonus plans are promoted by creditors, then such plans would strengthen

creditor rights and reduce the costs that the bankruptcy process imposes on creditors,

including deviation from the absolute priority rule. The coefficient on the KERP indicator

is negative but the estimate is not statistically significant.

Overall, we conclude that KERPs do not materially improve outcomes for creditors.

The likelihood of emergence from bankruptcy is unrelated to the provision of retention-

only bonuses; the time spent in bankruptcies in firms offering such plans is no different,

and the plans have no effect on APR violations.

5.2 Incentive Plans and Bankruptcy Outcomes

Since much of the criticism of KERPs is about retention-only plans, we next examine

if results differ when we examine the effect of incentive bonus plans relative to firms

27

that offer no bonuses or offer only retention bonuses. The incentive bonuses are often

contingent on the firm achieving a certain outcome or the firm reaching a pre-determined

milestone. These objectives are more frequently aligned with the interests of creditors.

Thus, contrary to the findings above, we expect incentive bonus plans to significantly

improve outcomes.

Columns (4) to (6) of Table 8 examine the effect of incentive bonus plans on the three

bankruptcy outcomes. The incentive-plan indicator takes a value of one if plans include

incentive bonus payments to key employees, and a value of zero otherwise. As described

earlier, many KERPs include incentive bonuses together with retention payments, while

a small number of plans include only incentive bonuses. In both cases, the incentive-plan

indicator is coded as one. As before, the regressions control for firm and bankruptcy

characteristics that are important in determining outcomes.

Incentive bonus plans frequently tie the compensation of key employees to a firm’s

emergence from Chapter 11, or to performance indicators that are tied to either EBITDA

or the enterprise value at emergence. Since incentive plans more frequently tie bonuses to

emergence rather than to liquidation, we expect the overall effect of incentive bonuses on

emergence to be positive. The bivariate probit estimates reported in column (4) confirm

this prediction. In Table 9, we separately examine the effect of these objectives on the

likelihood of emergence.

In column (5), we examine how the presence of incentive bonus plans is related to the

time spent in bankruptcy. Many incentive bonus plans directly tie bonuses to the speed

with which a bankruptcy is resolved. Specifically, managers are offered larger bonuses if

the plan is confirmed early; the firm will gradually reduce bonus payments as the plan

confirmation date moves into the future. The estimates show that the use of incentive

bonuses significantly reduces time spent in bankruptcy. The effect of incentive plans on

28

bankruptcy duration is much stronger compared to that in Column (2) where we examined

all plans (including the retention-only plans).

In column (6), we examine the effect of incentive bonus plans on the likelihood of

APR violation in Chapter 11. As discussed earlier, if bonus plans improve outcomes

for creditors, then they should reduce the costs that the bankruptcy process imposes on

creditors, including deviation from the APR. Consistent with this prediction, we find that

the coefficient on the incentive plan indicator is significantly negative.

The coefficient estimates on control variables have the predicted signs. The coefficient

estimate on Ln(assets) in emergence regressions is positive, although it is not statistically

significant.19 We expect leverage to affect positively the probability of emergence because

high leverage indicates that the firm suffers from financial, rather than economic, distress.

In addition, creditors of highly-levered firms are likely to favor continuation, given that

the claims of highly-levered firms are more risky. Consistently, we find that firms are more

likely to emerge if they have high leverage. Furthermore, we expect firms to have a higher

likelihood of emergence in pre-packaged bankruptcies, as a plan of reorganization often

accompanies a bankruptcy petition at filing. The results strongly support this prediction

as the coefficient estimates on pre-packaged bankruptcy are positive and significant at the

1% level in Columns (1) and (4). The Delaware filing dummy is negatively associated

with emergence.

We find that the presence of a creditors’ committee, a measure of bankruptcy com-

plexity, is associated with a longer time spent in bankruptcy. As expected, pre-packaged

bankruptcies are resolved more quickly. The only other variable that is significant in

19Larger firms are more likely to be reorganized because larger firms are more costly to liquidate dueto the financing constraints faced by potential buyers (Shleifer and Vishny, 1992; Aghion et al., 1992).Larger firms also have a considerably larger scope when reorganizing assets through restructuring andoperating improvements (Denis and Rodgers, 2007; Barniv and Agarwal, 2002; Lemmon et al., 2009).

29

the duration regressions is the presence of an equity committee, which is associated with

longer time spent in bankruptcy. Finally, the results suggest that APR violations are more

common in pre-packaged bankruptcies. These results are consistent with those reported

in Tashjian et al. (1996).

Overall, the findings suggest that bonus plans that offer incentive bonuses to key

employees increase the likelihood of a firm’s emergence from bankruptcy, reduce the time

that firms spend in bankruptcy, and lower the likelihood that APR is violated.

5.3 Plan Objectives and Bankruptcy Resolution

Table 9 examine whether specific objectives in retention and incentive plans differently

affect the probability of emergence. We focus on those plan objectives which appear most

frequently in KERPs. The logit estimates presented in Columns (1) and (2) show that

specific plan objectives in retention plans have no predictive ability in explaining a firm’s

emergence from bankruptcy. This finding is not surprising, since retention bonuses are

based on a minimum stay or on the length of stay until plan confirmation (which could

be either through a reorganization or liquidation).

Columns (3) to (6), on the other hand, examine the three specific objectives that are

commonly observed in incentive bonus plans. As described earlier, many of the bonus

plans link incentive payments to the firm’s emergence from Chapter 11. Many other

plans link bonuses to asset sales. These two objectives should have opposite effects on

the likelihood of a firm’s emergence. Column (3) examines the likelihood of emergence

when firms offer incentive plans that tie bonuses to emergence. The expected positive

coefficient on the emergence objective indicator suggests that emergence is more likely

when bonuses are linked to emergence. Conversely, results in column (4) show that

30

when the plan objective is to sell assets, emergence is less likely. Overall, the results

strongly suggest that incentive bonuses are important in explaining a firm’s emergence

from bankruptcy. In column (5), the effect of incentive bonus plans that link incentive

bonuses to targets based on firms’ EBITDA upon emergence is examined. The presence

of such plans is likely to once again positively affect emergence. The positive coefficient

on the EBITDA objective indicator is consistent with this prediction.

The fact that specific plan objectives differently affect the likelihood of a firm’s emer-

gence suggest that the nature of incentives matters significantly in bankrupt firms. The

stronger findings on the effect of incentive plans on outcomes suggest that provision of

incentive bonus payments significantly improves outcomes for creditors.

6 Conclusion

This paper examines the determinants of retention and incentive bonus plans in Chapter

11 bankruptcy and the effect that such plans have on bankruptcy outcomes. Many per-

ceive that retention bonus plans simply transfer value from creditors to managers. The

perception that managers are enriching themselves through such plans while lower level

workers are laid off has generated immense controversy in the media and the Congress.

However, companies have defended the use of these plans by arguing that key employee

retention plans are important to dissuade mission-critical employees from leaving the firm.

We find that measures of creditor power, such as the presence of creditors’ committees

and debtor-in-possession financing, significantly increase the likelihood of a bankrupt firm

implementing retention and incentive bonus plans. Similarly, these plans are more likely

to be used when employees have increased outside employment options. Overall, the

evidence generated through our study suggests that KERPs are more likely to be used

31

when creditors have increased control over the bankruptcy process and when there is

a greater risk of employees leaving the firm. We do not find evidence that entrenched

incumbent CEOs are more likely to be covered by KERPs. On the contrary, turnaround

specialists hired to improve and reorganize troubled companies are more likely to be

covered by these plans.

Furthermore, we examine the effect of KERPs on bankruptcy outcomes and find that

it is important to distinguish between plans that provides only retention bonuses and

those that provide both retention and incentive bonuses. While KERPs, in general,

do not have material effect on a firm’s likelihood of emergence from bankruptcy, plans

that provide incentive bonuses significantly increase the likelihood of a firm’s emergence.

Furthermore, incentive plans significantly reduce the time a firm spends in bankruptcy

and the likelihood of absolute priority rule deviation.

The nature of such incentives matters. When incentive plans tie bonuses to a firm’s

emergence or provide incentive bonuses contingent on EBITDA targets at emergence, the

likelihood of emergence increases. On the contrary, when incentive bonuses are tied to

asset sales, it becomes more likely that firms will, in fact, sell their assets.

Overall, the evidence in this study casts doubt on claims that KERPs are adopted

because creditors are ineffective in preventing managers from enriching themselves through

the payment of these bonuses. On the contrary, we find that creditor control is critical

in the payment of retention and incentive bonuses and that such plans generally improve

outcomes for creditors.

32

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34

Table 1: Use of KERPs in Chapter 11

The table reports annual distribution of firms adopting key employee retention plans. Columns 3 to 5

provide annual distribution of three different types of KERPs – plans that provide only retention bonuses,

plans that provide both retention and incentive bonuses, and finally plans that provide only incentive

bonuses. The initial sample includes all Chapter 11 filings by public U.S. firms with book assets above

$100 million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcy cases that were

dismissed and those that were still pending as of December 31, 2008. We also exclude financial firms,

utilities, and firms headquartered outside the U.S. Year is the year in which of filing of Chapter 11.

KERPs Featuring

Year Total Adopted Retentions Retention IncentivesFilings KERP Only w/Incentives Only

(1) (2) (3) (4) (5)

1996 14 (3.4%) 4 (29%) 3 (21%) 1 (7%) 0 (0%)1997 13 (3.1%) 5 (38%) 3 (23%) 0 (0%) 2 (15%)1998 24 (5.8%) 6 (25%) 5 (21%) 1 (4%) 0 (0%)1999 36 (8.6%) 15 (42%) 8 (22%) 7 (19%) 0 (0%)2000 72 (17.3%) 22 (31%) 9 (13%) 13 (18%) 0 (0%)2001 82 (19.7%) 30 (37%) 11 (13%) 18 (22%) 1 (1%)2002 67 (16.1%) 25 (37%) 10 (15%) 15 (22%) 0 (0%)2003 45 (10.8%) 23 (51%) 6 (13%) 10 (22%) 7 (16%)2004 27 (6.5%) 15 (56%) 7 (26%) 7 (26%) 1 (4%)2005 19 (4.6%) 10 (53%) 5 (26%) 5 (26%) 0 (0%)2006 11 (2.6%) 6 (55%) 0 (0%) 1 (9%) 5 (45%)2007 7 (1.7%) 3 (43%) 0 (0%) 0 (0%) 3 (43%)

Total 417 (100.0%) 164 (39%) 67 (16%) 78 (19%) 19 (5%)

35

Table 2: Summary Statistics

The table presents summary statistics of our sample firms. Panel A presents mean and medianvalues of firm characteristics in the year before bankruptcy. Panel B provides summary statistics ofbankruptcy-related variables. Panel C summarizes governance and CEO characteristics, while panelD tabulates bankruptcy outcomes and presents means and medians of time to resolution in monthsfor each of the three outcomes. The initial sample includes all Chapter 11 filings by U.S. publicfirms with book assets above $100 million (in constant 1980 dollars) from 1996 to 2007. We excludebankruptcy cases that were dismissed and those that were still pending as of December 31, 2008.We also exclude financial firms, utilities, and firms headquartered outside the U.S. The financial andownership data are as of the year before the filing. The variables are defined in Appendix Table 1.

Variable N Mean Median

Panel A: Firm Characteristics

Assets (in millions of 2008 dollars) 417 2040.36 661.81Leverage 417 1.02 0.92Industry-adjusted leverage 417 0.44 0.36EBITDA-to-assets 416 0.01 0.05Industry-adjusted EBITDA-to-assets 416 -0.07 -0.05Secured debt/assets 410 0.42 0.39Institutional ownership 417 0.27 0.23

Panel B: Bankruptcy Characteristics

Pre-packaged 417 0.29Delaware 417 0.44DIP financing 417 0.67Creditors’ committee 417 0.85Equity committee 417 0.11APRDev 417 0.17

Panel C: Governance and CEO Characteristics

Board independence 392 0.71 0.75Board size 392 7.67 7.00CEO-chairman 393 0.50 1.00CEO-founder 390 0.15 0.00CEO age 370 53.05 53.00CEO tenure 402 4.00 2.00CEO incumbent 405 0.41 0.00CEO internal hire 404 0.24 0.00CEO external hire 404 0.35 0.00CEO turnaround specialist 404 0.12 0.00

Panel D: Bankruptcy Outcomes

Bankruptcy duration (in months)

Outcome N (%) Mean Median

Reorganization 249 (59.7%) 13.58 10.23Acquisition 46 (11.0%) 18.06 18.10Liquidation 122 (29.3%) 23.72 16.88

Total 417 (100.0%) 17.04 13.53

36

Table 3: Details of KERPs

The table reports mean and median values of employee coverage of retention and incentive plans, the

bonuses paid under these plans, aggregate plan costs, and plan objectives for retention and incentive

plans. The initial sample includes all Chapter 11 filings by U.S public firms with book assets above $100

million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcy cases that were dismissed

and those that were still pending as of December 31, 2008. We also exclude financial firms, utilities, and

firms headquartered outside the U.S. The variables are defined in Appendix Table 1.

Retention Plans Incentive Plans

Plan Features N Mean Median N Mean Median

# of key employees in the plan 126 456.13 81.50 74 245.95 44.50# of key employees/total employees 126 0.06 0.02 74 0.05 0.01# of tier groups 109 3.89 3.00 69 3.30 3.00Key employees: highest-tier group 91 21.87 6.00 51 12.90 3.00Key employees: lowest-tier group 76 157.14 46.00 33 95.64 17.00Bonus (% of salary): highest-tier group 111 82.81 75.00 52 113.18 95.00Bonus (% of salary): lowest-tier group 91 34.17 30.00 39 31.21 25.00Plan includes CEO 142 0.79 1.00 96 0.81 1.00Plan includes non-CEO executives 142 0.99 1.00 97 0.95 1.00Plan includes other employees 142 0.86 1.00 97 0.72 1.00

Retention plan objectives:

Retention plan: minimum stay 124 0.85 1.00Minimum months of stay required 95 9.20 8.00Retention plan: plan confirmation 124 0.52 1.00

Incentive plan objectives:

Objective: emergence 97 0.48Objective: EBITDA 97 0.46Objective: asset sale 97 0.30Objective: enterprise value 97 0.19Objective: speed 97 0.13Objective: recovery 97 0.13

Plan Costs:

Total costs (in 2008 $ mill) 130 8.53 4.06 79 7.25 3.87Total costs/assets (%) 130 0.44 0.37 79 0.39 0.24Maximum pool (in 2008 $ mill) 120 9.45 4.69 68 16.11 4.15Maximum pool/assets (%) 120 0.50 0.44 68 0.64 0.32

37

Tab

le4:

Log

itM

odel

sof

KE

RP

Adop

tion

inC

hap

ter

11F

irm

s

Th

eta

ble

pre

sents

the

logi

tes

tim

ates

from

mod

els

that

rela

teK

ER

Ps

tom

easu

res

of

cred

itor

pow

eran

dem

plo

yees

’ou

tsid

eop

tion

s.T

he

init

ial

sam

ple

incl

ud

esal

lC

hap

ter

11fi

lin

gsby

U.S

.p

ub

lic

firm

sw

ith

book

ass

ets

ab

ove

$100

mil

lion

(in

con

stant

1980

doll

ars

)fr

om

1996

to2007.

We

excl

ud

eb

ankru

ptc

yca

ses

that

wer

ed

ism

isse

dan

dth

ose

that

wer

est

ill

pen

din

gas

of

Dec

emb

er31,

2008.

We

als

oex

clu

de

fin

an

cial

firm

s,u

tili

ties

,an

dfi

rms

hea

dqu

arte

red

outs

ide

the

U.S

.T

he

vari

ab

les

are

defi

ned

inA

pp

end

ixT

ab

le1.

All

regre

ssio

ns

contr

ol

for

Fam

a-F

ren

ch12

-in

du

stry

fixed

effec

ts.

Nu

mb

ers

inp

aren

thes

esare

z-va

lues

.∗∗∗ ,∗∗

an

d∗

den

ote

sign

ifica

nce

at

the

1%

,5%

,an

d10%

leve

ls,

resp

ecti

vely

.

(1)

(2)

(3)

(4)

(5)

(6)

Ln

(ass

ets)

0.46

5∗∗∗

0.4

50∗∗∗

0.5

29∗∗∗

0.4

75∗∗∗

0.4

06∗∗∗

0.3

43∗∗

(3.7

)(3

.5)

(3.9

)(3

.7)

(2.8

)(2

.2)

Pre

-pac

kage

d-0

.861∗∗∗

-1.0

30∗∗∗

-0.8

92∗∗∗

-0.9

73∗∗∗

-0.8

84∗∗∗

-0.8

29∗∗

(-2.

8)(-

3.2

)(-

2.7

)(-

3.0

)(-

2.7

)(-

2.3

)

Del

awar

e0.

215

0.2

34

0.3

15

0.1

71

0.3

28

0.3

84

(0.9

)(1

.0)

(1.3

)(0

.7)

(1.3

)(1

.4)

Cre

dit

ors’

com

mit

tee

2.21

9∗∗∗

2.2

42∗∗∗

2.2

76∗∗∗

2.1

46∗∗∗

2.3

59∗∗∗

2.2

66∗∗∗

(3.5

)(3

.4)

(3.4

)(3

.3)

(3.5

)(3

.3)

DIP

fin

anci

ng

1.19

2∗∗∗

1.2

82∗∗∗

1.2

36∗∗∗

1.1

82∗∗∗

1.2

70∗∗∗

1.2

22∗∗∗

(4.2

)(4

.4)

(4.0

)(3

.9)

(4.1

)(3

.5)

Ind

ust

ryin

dis

tres

s-0

.592

-0.6

06

-0.5

67

-0.5

71

-0.5

41

(-1.6

)(-

1.6

)(-

1.5

)(-

1.5

)(-

1.3

)

ThickEmplM

arkets

1.3

88∗∗∗

1.3

91∗∗∗

1.2

60∗∗∗

1.3

80∗∗∗

1.2

27∗∗

(3.2

)(3

.0)

(2.7

)(3

.0)

(2.3

)

IndCom

pGrowth

1.531∗∗

1.4

61∗

1.7

57∗∗

1.4

64∗

1.2

60

(2.0

)(1

.9)

(2.2

)(1

.9)

(1.5

)

Boa

rdin

dep

end

ence

0.0

91

-0.0

64

(0.1

)(-

0.1

)

CE

O-c

hai

rman

-0.1

53

0.1

48

(-0.6

)(0

.5)

Boa

rdsi

ze0.1

11∗∗

0.1

41∗∗

(2.1

)(2

.2)

38

Tab

le4

Con

tinued

(1)

(2)

(3)

(4)

(5)

(6)

CE

Oag

e≥

600.0

72

(0.2

)

CE

Ote

nure

0.0

04

(0.1

)

CE

O-f

oun

der

0.5

95

(1.5

)

CE

Oin

tern

alh

ire

0.0

33

(0.1

)

CE

Oex

tern

alh

ire

-0.3

41

(-0.8

)

CE

Otu

rnar

oun

dsp

ecia

list

0.5

52

(1.1

)

Constant

-6.1

32∗∗∗

-6.1

07∗∗∗

-6.6

21∗∗∗

-5.9

30∗∗∗

-6.6

54∗∗∗

-6.7

05∗∗∗

(-5.

6)(-

5.5

)(-

5.3

)(-

5.2

)(-

5.6

)(-

4.9

)

Pse

ud

oR

20.

190.2

20.2

20.2

20.2

30.2

1

Observations

417

415

390

392

390

346

39

Table 5: Multinomial Logit Models of Retention-Only Plans and Incentive Bonus Plans

This table reports results from multinomial logit regressions for the adoption of bonus plans. The referencecategory is the set of firms without KERPs. The alternative categories are firms that use bonus plansthat only pay retention bonuses and those that pay incentive bonuses (either with retention bonusesor without). The initial sample includes all Chapter 11 filings by U.S. public firms with book assetsabove $100 million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcy cases that weredismissed and those that were still pending as of December 31, 2008. We also exclude financial firms,utilities, and firms headquartered outside the U.S. The variables are defined in Appendix Table 1. Allregressions control for Fama-French 12-industry fixed effects. Numbers in parentheses are z-values. ∗∗∗,∗∗ and ∗ denote significance at the 1%, 5%, and 10% levels, respectively.

(1) (2) (3) (4)

Retention-Only Bonus Plans

Ln(assets) 0.341∗∗ 0.421∗∗ 0.364∗∗ 0.353∗

(2.2) (2.6) (2.3) (1.9)

Pre-packaged -0.744∗ -0.672 -0.682∗ -0.640(-1.9) (-1.6) (-1.7) (-1.5)

Delaware 0.333 0.392 0.199 0.397(1.1) (1.2) (0.6) (1.2)

Creditors’ committee 20.586∗∗∗ 20.644∗∗∗ 20.544∗∗∗ 20.679∗∗∗

(17.8) (15.2) (17.4) (17.2)

DIP financing 0.698∗ 0.619∗ 0.611∗ 0.660∗

(1.9) (1.7) (1.7) (1.7)

Industry in distress -0.335 -0.360 -0.308 -0.319(-0.7) (-0.7) (-0.6) (-0.6)

ThickEmplMarkets 1.823∗∗∗ 1.712∗∗∗ 1.614∗∗∗ 1.678∗∗∗

(3.4) (2.9) (2.9) (2.9)

IndCompGrowth 0.555 0.385 0.619 0.313(0.6) (0.4) (0.6) (0.3)

Board independence 0.817(0.8)

CEO-chairman 0.049

(0.2)

Board size 0.069(1.0)

Plans with Incentive Bonuses

Ln(assets) 0.517∗∗∗ 0.614∗∗∗ 0.549∗∗∗ 0.453∗∗∗

(3.6) (4.0) (3.7) (2.8)

Pre-packaged -1.297∗∗∗ -1.074∗∗ -1.255∗∗∗ -1.110∗∗

(-3.1) (-2.5) (-3.0) (-2.6)

40

Table 5 Continued

(1) (2) (3) (4)

Delaware 0.162 0.249 0.144 0.281(0.6) (0.8) (0.5) (0.9)

Creditors’ committee 1.380∗∗ 1.428∗∗ 1.271∗ 1.550∗∗

(2.0) (2.0) (1.8) (2.2)

DIP financing 1.895∗∗∗ 1.906∗∗∗ 1.813∗∗∗ 1.913∗∗∗

(4.6) (4.4) (4.2) (4.4)

Industry in distress -0.808∗ -0.837∗ -0.814∗ -0.792∗

(-1.7) (-1.8) (-1.7) (-1.7)

ThickEmplMarkets 1.168∗∗ 1.272∗∗ 1.059∗∗ 1.253∗∗

(2.3) (2.3) (2.0) (2.3)

IndCompGrowth 2.420∗∗∗ 2.477∗∗∗ 2.805∗∗∗ 2.514∗∗∗

(2.6) (2.7) (3.0) (2.7)

Board independence -0.625(-0.7)

CEO-chairman -0.327(-1.1)

Board size 0.127∗∗

(2.1)

Constant -6.642∗∗∗ -6.913∗∗∗ -6.479∗∗∗ -7.321∗∗∗

(-5.3) (-4.9) (-5.0) (-5.5)

Pseudo R2 0.21 0.21 0.20 0.22

Observations 415 390 392 390

41

Tab

le6:

Tob

itE

stim

ates

ofK

ER

PF

eatu

res

Th

eta

ble

pre

sents

the

tob

ites

tim

ates

from

mod

els

that

rela

teth

eK

ER

Pp

lan

featu

res

tofi

rman

db

an

kru

ptc

ych

ara

cter

isti

cs.

Th

ein

itia

lsa

mp

lein

clu

des

all

Ch

apte

r11

fili

ngs

by

U.S

pu

bli

cfi

rms

wit

hb

ook

ass

ets

ab

ove

$100

mil

lion

(in

con

stant

1980

doll

ars

)fr

om

1996

to2007.

We

excl

ud

eb

ankru

ptc

yca

ses

that

wer

ed

ism

isse

dan

dth

ose

that

wer

est

ill

pen

din

gas

of

Dec

emb

er31,

2008.

We

als

oex

clu

de

fin

an

cial

firm

s,u

tili

ties

,an

dfi

rms

hea

dqu

arte

red

outs

ide

the

U.S

.T

he

vari

ab

les

are

defi

ned

inA

pp

end

ixT

ab

le1.

All

regre

ssio

ns

contr

ol

for

Fam

a-F

ren

ch12

-in

du

stry

fixed

effec

ts.

Nu

mb

ers

inp

aren

thes

esare

z-va

lues

.∗∗∗ ,∗∗

an

d∗

den

ote

sign

ifica

nce

at

the

1%

,5%

,an

d10%

leve

ls,

resp

ecti

vely

.

Key

pla

nem

plo

yees

/B

onu

s(%

Sal

ary)

Pla

nC

ost

/A

sset

s(%

)M

ax

Pool/

Ass

ets

(%)

Key

pla

nem

plo

yees

/B

onu

s(%

of

Sala

ry)

Pla

nC

ost

/A

sset

s(%

)M

ax

Pool/

Ass

ets

(%)

Tot

alem

plo

yees

Hig

hes

tti

erT

ota

lem

plo

yees

Hig

hes

tti

er

Ret

enti

on

Bonu

ses

Ince

nti

ve

Bonu

ses

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

Ln

(ass

ets)

0.03

2∗∗∗

29.2

26∗∗∗

0.1

07∗∗∗

0.1

02∗∗

0.0

31∗∗

34.4

09∗

0.1

24∗∗

0.4

05∗∗∗

(3.3

)(3

.9)

(2.7

)(2

.3)

(2.5

)(1

.8)

(2.3

)(2

.8)

Pre

-pac

kage

d-0

.034

-46.

599∗∗

-0.2

90∗∗

-0.3

39∗∗∗

-0.0

43

-54.7

54

-0.3

02∗

-0.9

18∗∗

(-1.

3)(-

2.3)

(-2.6

)(-

2.7

)(-

1.2

)(-

1.0

)(-

1.9

)(-

2.1

)

Del

aware

0.03

117

.709

0.0

70

0.1

55∗

0.0

33

-13.6

91

0.1

29

0.5

39∗

(1.6

)(1

.2)

(0.8

)(1

.7)

(1.3

)(-

0.3

)(1

.2)

(1.8

)

Cre

dit

ors’

com

mit

tee

0.18

7∗∗∗

130.

867∗∗∗

0.6

74∗∗∗

0.9

85∗∗∗

0.1

23∗∗

103.6

65

0.2

45

0.8

41

(3.5

)(3

.1)

(3.2

)(3

.4)

(2.0

)(1

.2)

(1.1

)(1

.2)

DIP

fin

anci

ng

0.08

0∗∗∗

58.8

35∗∗∗

0.3

04∗∗∗

0.3

14∗∗∗

0.1

20∗∗∗

231.5

34∗∗∗

0.5

54∗∗∗

1.2

38∗∗∗

(3.1

)(3

.1)

(2.9

)(2

.7)

(3.3

)(3

.3)

(3.6

)(2

.9)

ThickEmplM

arkets

0.07

8∗∗

60.6

36∗∗

0.3

57∗∗

0.3

91∗∗

0.0

37

58.0

08

0.1

15

0.2

16

(2.3

)(2

.2)

(2.4

)(2

.4)

(0.9

)(0

.8)

(0.6

)(0

.4)

IndCom

pGrowth

0.04

247

.099

0.1

02

0.2

87

0.1

61∗∗

215.0

13∗

0.6

29∗

1.6

52∗

(0.7

)(1

.0)

(0.4

)(1

.0)

(2.1

)(1

.7)

(1.9

)(1

.8)

Ind

ust

ryin

dis

tres

s0.

000

-7.1

78-0

.144

-0.1

25

-0.0

42

0.2

80

-0.2

14

-0.5

73

(0.0

)(-

0.3)

(-1.1

)(-

0.9

)(-

1.0

)(0

.0)

(-1.2

)(-

1.2

)

Constant

-0.5

02∗∗∗

-383

.245∗∗∗

-1.5

80∗∗∗

-1.9

35∗∗∗

-0.5

17∗∗∗

-753.8

81∗∗∗

-1.9

62∗∗∗

-5.9

11∗∗∗

(-5.

4)(-

5.3)

(-4.2

)(-

4.3

)(-

4.5

)(-

4.0

)(-

4.1

)(-

4.5

)

Pse

ud

oR

20.

580.

060.1

50.1

60.3

60.0

50.1

30.1

2Observations

396

379

400

390

392

368

397

386

42

Tab

le7:

CE

OP

arti

cipat

ion

inK

ER

Ps

Th

eta

ble

pre

sents

logi

tes

tim

ates

from

regr

essi

ons

that

pre

dic

tth

ep

art

icip

ati

on

of

CE

Os

inK

ER

Ps

as

afu

nct

ion

of

CE

Och

ara

cter

isti

cs,

gove

rnan

ceva

riab

les,

firm

and

ban

kru

ptc

ych

aract

eris

tics

.T

he

init

ial

sam

ple

incl

ud

esall

Ch

ap

ter

11

fili

ngs

by

U.S

.pu

bli

cfi

rms

wit

hb

ook

asse

tsab

ove

$100

mil

lion

(in

con

stan

t19

80d

olla

rs)

from

1996

to2007.

We

excl

ud

eb

an

kru

ptc

yca

ses

that

wer

ed

ism

isse

dan

dth

ose

that

wer

est

ill

pen

din

gas

ofD

ecem

ber

31,

2008

.W

eal

soex

clu

de

fin

an

cial

firm

s,u

tili

ties

,an

dfi

rms

hea

dqu

art

ered

ou

tsid

eth

eU

.S.

Th

eva

riab

les

are

defi

ned

inA

pp

end

ixT

able

1.A

llre

gres

sion

sco

ntr

ol

for

Fam

a-F

ren

ch12-i

nd

ust

ryfi

xed

effec

ts.

Nu

mb

ers

inp

are

nth

eses

are

z-va

lues

.∗∗∗ ,∗∗

and∗

den

ote

sign

ifica

nce

atth

e1%

,5%

,an

d10

%le

vels

,re

spec

tive

ly.

CE

OP

art

icip

ati

on

inK

ER

Ps

CE

OP

art

icip

ati

on

inIn

centi

ve

Pla

ns

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

CE

Oag

e≥

60-0

.217

-0.2

94

-0.2

82

-0.2

23

-0.6

77

-0.7

68∗

-0.7

17

-0.8

89∗

(-0.

7)(-

0.9)

(-0.8

)(-

0.6

)(-

1.6

)(-

1.7

)(-

1.6

)(-

1.8

)C

EO

tenure

0.02

50.

026

0.0

31

0.0

27

0.0

07

0.0

10

0.0

18

0.0

17

(0.9

)(0

.9)

(1.1

)(0

.8)

(0.2

)(0

.3)

(0.5

)(0

.4)

CE

O-f

oun

der

0.03

40.

045

0.1

51

0.3

43

0.3

020.2

88

0.4

37

0.7

83

(0.1

)(0

.1)

(0.4

)(0

.8)

(0.7

)(0

.7)

(1.0

)(1

.6)

CE

Oin

cum

ben

t-0

.161

-0.0

56

(-0.

5)(-

0.1

)C

EO

inte

rnal

hir

e0.

256

0.2

64

0.3

38

0.3

10

0.2

49

0.3

60

(0.7

)(0

.7)

(0.8

)(0

.7)

(0.6

)(0

.7)

CE

Oex

tern

alh

ire

-0.2

18

-0.1

83

-0.3

38

-0.4

30

-0.3

25

-0.5

81

(-0.

6)

(-0.5

)(-

0.8

)(-

0.9

)(-

0.7

)(-

1.0

)C

EO

turn

arou

nd

spec

iali

st0.

905∗∗

0.8

36∗

0.5

65

0.7

90

0.5

45

0.2

33

(2.1

)(1

.9)

(1.2

)(1

.4)

(0.9

)(0

.4)

Boa

rdsi

ze0.1

61∗∗∗

0.1

34∗∗

0.1

78∗∗∗

0.1

13

(3.0

)(2

.0)

(2.9

)(1

.6)

Boa

rdin

dep

end

ence

0.8

42

0.8

51

-0.3

48

-0.8

02

(1.0

)(0

.9)

(-0.4

)(-

0.7

)C

EO

-ch

airm

an0.3

59

0.1

27

0.1

26

-0.2

58

(1.3

)(0

.4)

(0.4

)(-

0.7

)L

n(a

sset

s)0.2

26

0.4

38∗∗

(1.5

)(2

.5)

Pre

pac

kage

d-0

.600∗

-0.6

84

(-1.7

)(-

1.4

)D

elaw

are

0.3

57

0.4

49

(1.3

)(1

.3)

Cre

dit

ors’

com

mit

tee

2.0

08∗∗∗

1.2

94

(3.0

)(1

.5)

DIP

fin

anci

ng

0.9

60∗∗∗

1.7

20∗∗∗

(2.7

)(3

.1)

43

Tab

le7

Con

tinued

CE

OP

arti

cip

ati

on

inK

ER

Ps

CE

OP

art

icip

ati

on

inIn

centi

veP

lan

s

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

ThickEmplM

arkets

0.4

20

0.2

73

(0.8

)(0

.4)

IndCom

pGrowth

0.6

03

2.2

97∗∗

(0.7

)(2

.1)

Ind

ust

ryin

dis

tres

s-0

.029

-0.2

61

(-0.1

)(-

0.5

)

Constant

-0.4

21-0

.545

-2.5

98∗∗∗

-6.3

27∗∗∗

-1.0

82∗∗

-1.0

77∗∗

-2.3

57∗∗

-6.7

93∗∗∗

(-1.

0)(-

1.2)

(-3.2

)(-

4.7

)(-

2.3

)(-

2.1

)(-

2.4

)(-

4.2

)

Pse

ud

oR

20.

030.

030.0

70.1

80.0

40.0

60.0

80.2

2

Observations

354

354

345

344

355

355

346

345

44

Tab

le8:

Eff

ect

ofR

eten

tion

and

Ince

nti

veP

lans

onB

ankru

ptc

yO

utc

omes

Th

eta

ble

exam

ines

the

effec

tof

rete

nti

onon

lyp

lan

son

emer

gen

cefr

om

ban

kru

ptc

y,d

ura

tion

of

ban

kru

ptc

y,an

dab

solu

tep

riori

tyru

led

evia

tion

.C

olu

mn

s(1

)an

d(3

)p

rese

nt

resu

lts

from

biv

ari

ate

pro

bit

regre

ssio

ns

of

reorg

an

izin

gin

ban

kru

ptc

y.C

olu

mn

s(2

)an

d(5

)p

rese

nt

resu

lts

from

trea

tmen

tre

gres

sion

sof

the

log

ofd

ura

tion

.F

inall

y,C

olu

mn

s(4

)an

d(6

)p

rese

nt

resu

lts

from

biv

ari

ate

pro

bit

regre

ssio

ns

of

AP

Rvio

lati

ons.

Th

ein

itia

lsa

mp

lein

clu

des

all

Ch

ap

ter

11

fili

ngs

by

U.S

pu

bli

cfi

rms

wit

hb

ook

ass

ets

ab

ove

$100

mil

lion

(in

con

stant

1980

dol

lars

)fr

om19

96to

2007

.W

eex

clu

de

ban

kru

ptc

yca

ses

that

wer

ed

ism

isse

dan

dth

ose

that

wer

est

ill

pen

din

gas

of

Dec

emb

er31,

2008.

We

also

excl

ud

efi

nan

cial

firm

s,u

tili

ties

,an

dfi

rms

hea

dqu

art

ered

ou

tsid

eth

eU

.S.

Th

eva

riab

les

are

defi

ned

inA

pp

end

ixT

ab

le1.

All

regre

ssio

ns

contr

olfo

rF

ama-

Fre

nch

12-i

nd

ust

ryfi

xed

effec

ts.

Nu

mb

ers

inp

are

nth

eses

are

z-va

lues

.∗∗∗ ,∗∗

an

d∗

den

ote

sign

ifica

nce

at

the

1%

,5%

,an

d10

%le

vel

s,re

spec

tive

ly.

Em

erge

nce

Du

rati

on

APRDev

Em

ergen

ceD

ura

tion

APRDev

(1)

(2)

(3)

(4)

(5)

(6)

KE

RP

1.02

8-0

.175

-0.4

99

(1.3

)(-

0.4

)(-

0.5

)

Ince

nti

ve1.6

75∗∗∗

-0.6

43∗∗∗

-1.9

95∗∗∗

(15.2

)(-

3.1

)(-

11.1

)

Cre

dit

ors’

com

mit

tee

-0.5

340.7

41∗∗∗

-0.2

30

-0.4

36∗

0.7

46∗∗∗

-0.0

55

(-1.

5)(4

.9)

(-0.8

)(-

1.8

)(6

.2)

(-0.3

)

DIP

fin

anci

ng

-0.0

10-0

.012

-0.1

48

-0.1

75

0.0

63

0.2

45

(-0.

0)(-

0.1

)(-

0.6

)(-

1.1

)(0

.7)

(1.4

)

Ln

(ass

ets)

0.10

70.0

59

0.1

58

0.0

35

0.0

84∗∗

0.2

07∗∗∗

(0.9

)(1

.2)

(1.3

)(0

.5)

(2.0

)(2

.8)

Ind

ust

ry-a

dju

sted

leve

rage

0.62

9∗∗

-0.1

10

0.0

71

0.4

69∗∗∗

-0.0

81

0.1

93

(2.2

)(-

1.2

)(0

.3)

(2.6

)(-

0.9

)(1

.1)

Ind

ust

ry-a

dju

sted

RO

A-0

.134

0.0

64

0.0

14

-0.1

06

0.1

11

0.4

18

(-0.

3)(0

.3)

(0.0

)(-

0.3

)(0

.6)

(0.8

)

Pre

-pac

kage

d1.

406∗∗∗

-1.0

48∗∗∗

1.2

02∗∗∗

1.2

93∗∗∗

-1.1

17∗∗∗

0.4

69∗∗∗

(6.8

)(-

8.4

)(4

.8)

(7.0

)(-

10.9

)(2

.7)

Del

awar

e-0

.351∗∗

-0.0

62

0.1

25

-0.2

73∗∗

-0.0

54

0.1

18

(-2.

4)(-

0.8

)(0

.7)

(-2.1

)(-

0.7

)(0

.8)

Sec

ure

dd

ebt/

asse

ts0.

311

-0.1

04

-0.3

36

0.318

-0.1

21

-0.1

71

(1.0

)(-

1.4

)(-

1.0

)(1

.3)

(-1.6

)(-

0.7

)

Inst

itu

tion

alow

ner

ship

0.00

30.1

00

0.4

00

-0.2

88

0.2

24

0.7

64∗∗

(0.0

)(0

.6)

(0.9

)(-

1.0

)(1

.3)

(2.5

)

45

Tab

le8

Con

tinued

Em

erge

nce

Du

rati

on

APRDev

Em

erge

nce

Du

rati

on

APRDev

(1)

(2)

(3)

(4)

(5)

(6)

Equ

ity

com

mit

tee

0.37

30.

223∗

0.3

89

0.3

50

0.1

95

0.1

66

(1.4

)(1

.9)

(1.4

)(1

.6)

(1.6

)(0

.7)

Ind

ust

ryin

dis

tres

s0.

125

0.0

87

-0.0

90

0.2

11

0.0

38

-0.3

03

(0.5

)(0

.8)

(-0.3

)(1

.1)

(0.3

)(-

1.4

)

Constant

-1.0

001.

962∗∗∗

-2.2

07∗∗∗

-0.4

51

1.8

31∗∗∗

-2.1

36∗∗∗

(-1.

1)(5

.6)

(-2.6

)(-

0.8

)(5

.9)

(-3.7

)

Wal

dχ2

210.

7∗∗∗

401.

2∗∗∗

158.1∗∗∗

297.4∗∗∗

367.0∗∗∗

185.9∗∗∗

Observations

408

408

408

408

408

408

46

Tab

le9:

Pla

nO

bje

ctiv

esan

dR

eorg

aniz

atio

nin

Ban

kru

ptc

y

Th

eta

ble

pre

sents

esti

mat

esfr

omlo

git

regr

essi

on

sth

at

exam

ine

the

effec

tof

spec

ific

pla

nob

ject

ives

on

the

like

lih

ood

of

afi

rm’s

emer

gen

cefr

omb

ankru

ptc

y.T

he

init

ial

sam

ple

incl

ud

esal

lC

hap

ter

11

fili

ngs

by

U.S

.p

ub

lic

firm

sw

ith

book

ass

ets

ab

ove

$100

mil

lion

(in

con

stant

1980

dol

lars

)fr

om19

96to

2007

.W

eex

clu

de

ban

kru

ptc

yca

ses

that

wer

ed

ism

isse

dan

dth

ose

that

wer

est

ill

pen

din

gas

of

Dec

emb

er31,

2008.

We

also

excl

ud

efi

nan

cial

firm

s,u

tili

ties

,an

dfi

rms

hea

dqu

art

ered

ou

tsid

eth

eU

.S.

Th

eva

riab

les

are

defi

ned

inA

pp

end

ixT

ab

le1.

All

regre

ssio

ns

contr

olfo

rF

ama-

Fre

nch

12-i

nd

ust

ryfi

xed

effec

ts.

Nu

mb

ers

inp

are

nth

eses

are

z-va

lues

.∗∗∗ ,∗∗

an

d∗

den

ote

sign

ifica

nce

at

the

1%

,5%

,an

d10

%le

vel

s,re

spec

tive

ly.

(1)

(2)

(3)

(4)

(5)

(6)

Ret

enti

onp

lan

:m

inim

um

stay

0.37

50.8

11∗∗

(1.2

)(2

.2)

Ret

enti

onp

lan

:p

lan

con

firm

atio

n-0

.004

-0.5

62

(-0.0

)(-

1.3

)

Ob

ject

ive:

emer

gen

ce1.1

82∗∗∗

1.5

77∗∗∗

(2.7

)(2

.6)

Ob

ject

ive:

asse

tsa

le-2

.459∗∗∗

-3.2

19∗∗∗

(-3.7

)(-

4.2

)

Ob

ject

ive:

EB

ITD

A0.8

28∗∗

1.0

83∗∗

(2.0

)(2

.1)

Cre

dit

ors’

com

mit

tee

-0.4

51-0

.385

-0.4

23

-0.2

69

-0.4

10

-0.4

47

(-0.

9)(-

0.8

)(-

0.9

)(-

0.5

)(-

0.8

)(-

0.9

)

DIP

fin

anci

ng

0.11

10.1

74

0.1

56

0.3

54

0.1

97

-0.0

15

(0.4

)(0

.6)

(0.5

)(1

.2)

(0.7

)(-

0.0

)

Ln

(ass

ets)

0.26

2∗0.3

06∗∗

0.2

86∗∗

0.3

10∗∗

0.3

04∗∗

0.1

57

(1.9

)(2

.2)

(2.2

)(2

.3)

(2.3

)(1

.1)

Ind

ust

ry-a

dju

sted

leve

rage

1.71

3∗∗∗

1.7

47∗∗∗

1.3

40∗∗∗

1.3

81∗∗∗

1.3

55∗∗∗

1.7

52∗∗∗

(3.7

)(3

.7)

(3.1

)(3

.2)

(3.2

)(3

.5)

Ind

ust

ry-a

dju

sted

RO

A0.

499

0.5

11

0.2

54

0.3

13

0.2

63

0.5

66

(0.8

)(0

.8)

(0.4

)(0

.5)

(0.4

)(0

.8)

Pre

-pac

kage

d2.

046∗∗∗

1.9

79∗∗∗

2.1

50∗∗∗

1.9

82∗∗∗

2.1

25∗∗∗

2.0

74∗∗∗

(5.3

)(5

.1)

(5.7

)(5

.2)

(5.6

)(5

.2)

Del

awar

e-0

.436∗

-0.4

24

-0.4

97∗

-0.4

79∗

-0.4

93∗

-0.4

58

(-1.

7)(-

1.6

)(-

2.0

)(-

1.9

)(-

2.0

)(-

1.6

)

Sec

ure

dd

ebt/

asse

ts1.

135∗

1.0

86∗

0.6

71

0.6

88

0.6

74

1.3

13∗∗

(1.9

)(1

.8)

(1.3

)(1

.3)

(1.3

)(2

.0)

47

Tab

le9

Con

tinued

(1)

(2)

(3)

(4)

(5)

(6)

Inst

itu

tion

alow

ner

ship

0.41

50.4

58

0.1

25

0.8

54

0.3

29

0.6

56

(0.8

)(0

.8)

(0.2

)(1

.5)

(0.6

)(1

.1)

Equ

ity

com

mit

tee

0.83

1∗

0.8

32∗

0.9

51∗∗

0.6

66

0.8

04∗

0.7

61

(1.8

)(1

.8)

(2.1

)(1

.5)

(1.8

)(1

.5)

Ind

ust

ryin

dis

tres

s0.

304

0.2

66

0.2

08

0.1

43

0.1

86

0.5

21

(0.8

)(0

.7)

(0.5

)(0

.4)

(0.5

)(1

.3)

Constant

-2.4

92∗∗

-2.7

13∗∗

-2.3

25∗∗

-2.6

67∗∗

-2.5

27∗∗

-1.8

65

(-2.

3)(-

2.5

)(-

2.2

)(-

2.5)

(-2.4

)(-

1.6

)

Pse

ud

oR

20.

260.2

60.2

60.2

80.2

50.3

4

Observations

391

391

410

410

410

391

48

Appendix Table 1: Variable Definitions and Data Sources

The table provides definition of key variables. Data sources for firm characteristics and post-emergenceperformance are BRD, BankruptcyData.com, Compustat, 10Ks, Execucomp, and Thomson Reuters Own-ership Database (13Fs). Data sources for firm characteristics are BRD, BankruptcyData.com, Factiva,8K filings, and bankruptcy plans. Details on KERPs are obtained from BankruptcyData.com, Factiva,PACER, Parcels Inc., and National Archives.

Variable Definition

Firm Characteristics

Assets Book value of assets (in 2008 dollars)Leverage Total liabilities to assets ratioEBITDA-to-assets Ratio of EBITDA to book assetsSecured debt/assets Ratio of secured debt to book assetsInstitutional ownership Institutional ownership (in %)Industry in distress 0-1 dummy varaible, =1 if the median stock return of same 2-digit

SIC industry is -30% or less in the year before a firm files for bankruptcy.ThickEmplMarkets 0-1 dummy variable, = 1 if there are 20 or more firms

in the same-2-digit industry and headquarteredwithin 100 km of the company in bankruptcy.

IndCompGrowth Industry median growth in salary and bonus of non-CEO executivesin the year before the Chapter 11 filing.

Bankruptcy Characteristics

Pre-packaged 0-1 dummy variable, = 1 if bankruptcy is prepackagedor prenegotiated

Delaware 0-1 dummy variable, = 1 if bankruptcy filed in DelawareDIP financing 0-1 dummy variable, =1 if debtor obtained DIP financingCreditors’ committee 0-1 dummy variable, = 1 if creditor committee appointedEquity committee 0-1 dummy variable, = 1 if equity committee appointedReorganization 0-1 dummy variable, = 1 if firm reorganized in Chapter 11Liquidation 0-1 dummy variable, = 1 if firm is liquidatedAcquisition 0-1 dummy variable, = 1 if firm is acquiredDuration Months in bankruptcy from filing to plan confirmationAPRDev 0-1 dummy variable, =1 if equity holder receive payoffs

before creditors are paid in full.

Governance and CEO Characteristics

Board independence 0-1 dummy variable, =1 if a majority of board members are independentBoard size Number of board membersCEO-chairman 0-1 dummy variable, =1 if CEO is also chairman of the boardCEO-founder 0-1 dummy variable, =1 if CEO is also the firm’s founderCEO age Age of CEOCEO tenure Tenure as CEO with the firmCEO incumbent 0-1 dummy variable, =1 if CEO has been with the firm from before filingCEO internal hire 0-1 dummy variable, =1 if the newly-hired CEO is hired internallyCEO external hire 0-1 dummy variable, =1 if the newly-hired CEO is hired externallyCEO turnaround specialist 0-1 dummy variable, =1 if the external hire is a turnaround specialist

49

Appendix Table 1 continued

Variable Definition

Key Employee Retention Plans

KERP 0-1 dummy variable, = 1 if retention/incentive plan approvedRetention 0-1 dummy variable, = 1 if firm offers retention bonusesIncentive 0-1 dummy variable, = 1 if firm offers incentive bonusesKey employees # key employees in planKey employees/total employees # of key employees/Total employeesTier groups Number of tier groupsEmployees: highest tier group # of employees in highest tier groupEmployees: lowest tier group # of employees in lowest tier groupRetention bonus-highest tier Bonus (as % of salary) in highest tier groupRetention bonus-lowest tier Bonus (as % of salary) in lowest tier groupCEO in retention plan CEO is included in the retention planNon-CEO execs in retention plan Senior execs (other than CEO) in the retention planOther managers in plan Other employees in the retention planMinimum months of stay Minimum months of stay required to receive bonusBonus on minimum stay Fraction of bonus paid on minimum stayBonus on plan confirmation Fraction of bonus paid on plan confirmation

Objectives in Retention Plans

Retention: min stay 0-1 dummy variable, = 1 if retention bonus tied to minimum stayRetention: plan confirmation 0-1 dummy variable, = 1 if retention bonus tied to plan confirmation.

Objectives in Incentive Plans

Objective: emergence 0-1 dummy variable, = 1 if objective is tied to reorganizationObjective: EBITDA 0-1 dummy variable, = 1 if objective is tied to EBITDAObjective: asset sale 0-1 dummy variable, = 1 if objective is asset saleObjective: enterprise value 0-1 dummy variable, = 1 if objective is tied to enterprise valueObjective: speed 0-1 dummy variable, = 1 if objective is tied to speed of restructuringObjective: debt recovery 0-1 dummy variable, = 1 if objective is debt recovery.

50

Appendix A. KERP Examples from Court Motions

and Approvals

Examples of key employee retention and incentive plans taken from court document (such as motionsand orders approving key employment retention or incentive plans for firms in Chapter 11)

RETENTION PLAN FOR STAYING WITH THE DEBTOR

Excerpts from “Order Granting Debtors’ Motion to Approve Key Employee Retention Plan” for KittyHawk, Inc. dated August 23, 2000 by the US Bankruptcy Court for the Northern District of Texas.

IT IS, THEREFORE, ORDERED AND DECREED that the Key Employee listed on Ex-hibit “A” who retain employment with Kitty Hawk, Inc. or a Successor to the earlier of theeffective date of a Plan of Reorganization or January 1, 2001, shall be paid a retention bonusequal to six (6) months salary, payable in six monthly instalments beginning on the earlierof the effective date of a plan of reorganization or January 1, 2001, if these cases remain inChapter 11. No bonus would be payable (and any unpaid bonus would be forfeited) if a KeyEmployee: (a) resigns, (b) is terminated for cause or (c) does not execute a covenant notto compete with the Debtors (or their successors under a plan of reorganization) throughDecember 31, 2001.

Excerpts from “Motion for an Order Pursuant to 11 U.S.C. 105(a) and 363(b) Authorizing the Debtorsto Implement a Key Employee Retention Plan” for Horizon PCS, Inc. dated August 22, 2003 by theUS Bankruptcy Court for the Northern District of Ohio.

The Debtors propose to provide stay bonuses (the “Stay Bonuses”) to the 45 Key Employeesthat the Debtors deem to be so critical to their operations that the loss of such employees’services would cost the Debtors more than the cost of the Stay Bonus and other benefitsprovided under the Retention Plan. The Debtors selected the 45 Key Employees basedon their skill sets and knowledge, which are essential to the operation of the Debtors’businesses during these Chapter 11 restructurings, and other factors such as the likelihoodof their leaving for other employment opportunities. The Stay bonus are designed to inducethe 45 Key Employees to remain in the Debtors’ employ through the pendency of thesechapter 11 cases, or for as long as the Debtors require their services.

The Stay Bonus will be earned by each of qualifying Key Employee in the amounts andtimes set forth below, and will be paid as soon as practicable thereafter.

A. 25% (the “First Payment”) on the 45th day after the Petition Date;

B. 25% (the “Second Payment”) on earlier of: (1) confirmation of a plan of reorganiza-tion, (2) a Court order approving sale of substantially all assets becoming final, and(3) 105 days after the First Payment;

C. 50% upon the earlier of: (1) consummation of a Qualifying Event and upon earlierof (a) involuntary termination of employment (in which case the employees will beentitled to the greater of the remaining Stay Bonus or his/her Severance Pay); and (b)90 days after consummation of Qualifying Event; and (2) 190 days after the SecondPayment.

Excerpts from “Motion of the Debtors Pursuant to Sections 363(b) and 105(a) of the Bankruptcy Codefor Authorization to Establish a Key Employee Retention Plan” filed by WorldCom Inc. dated October18, 2002 with the US Bankruptcy Court for the Southern District of New York.

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The Debtors have to date identified approximately 329 Key Employees who will participatein the Retention Plan. In developing the Retention Plan, the Debtors classified those KeyEmployees into four groups (each a “Group”) based on each employee’s role in the Companyand expected contribution to the reorganization efforts of the Debtors:

• Group 1 includes 4 Key Employees (the “Group 1 Employees”) who hold the most se-nior positions at WorldCom. None of these employees will participate in the RetentionPlan.

• Group 2 includes 25 Key Employees (the “Group 2 Employees”). The Stay Bonus foreach Group 2 Employee is equal to 65 % of the individual’s annual base compensation,subject to a cap of $125,000. The range of Stay Bonuses for Group 2 Employees isexpected to be from $90,000 to $125,000.

• Group 3 includes 90 Key Employees (the “Group 3 Employees”). The Stay Bonus foreach Group 3 Employee is equal to 50% of the individual’s annual base compensation,subject to a cap of $125,000. The range of Stay Bonuses for Group 3 Employees isexpected to be from $47,000 to $125,000.

• Group 4 includes approximately 210 Key Employees (the “Group 4 Employees”). TheStay Bonus for each Group 4 Employee is equal to 35% of the individual’s annual basecompensation, subject to a cap of $125,000. The range of Stay Bonuses for Group 4Employees is expected to be from $20,000 to $90,000.

The Retention Plan provides bonuses designed to encourage Key Employees to both remainemployed by the Debtors throughout the reorganization process and to work productivelyto ensure that the Debtors complete their reorganization in a timely and efficient manner.The Retention Plan provides for a stay bonus (the “Stay Bonus”) if the Key Employeeremains employed by the Debtors on specific target dates. The Stay Bonus for any KeyEmployee is equal to a percentage of the individual’s annual base compensation accordingto the classification of the Key Employee set forth below. The Debtors propose to pay theStay Bonuses pursuant to the following schedule:

• 25% of the Stay Bonus paid on December 1, 2002,

• 25% of the Stay Bonus paid on March 31, 2003, and

• 50% of the Stay Bonus paid 60 days after confirmation of a plan of reorganization.

In addition, the Retention Plan provides that each Key Employee who remains employed bythe Debtors on the date that a plan of reorganization is confirmed (the “Plan ConfirmationDate”) will receive an additional bonus amount equal to 10% of the Key Employee’s StayBonus (the “Plan Progress Bonus”). The Plan Progress Bonus would be earned if the PlanConfirmation Date occurs by December 2003. Should the Plan Confirmation Date occurearlier, the Plan Progress would increase as set forth on the schedule below:

• 100% of the Plan Progress Bonus if the Plan Confirmation Date occurs in December2003;

• 150% of the Plan Progress Bonus if the Plan Confirmation Date occurs in November2003;

• 200% of the Plan Progress Bonus if the Plan Confirmation Date occurs in October2003; and

• 250% of the Plan Progress Bonus if the Plan Confirmation Date occurs on or beforeSeptember 30, 2003.

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RETENTION BONUS TIED TO STAY AND INCENTIVE BONUS TIED TO EMER-GENCE

Excerpts from “Debtors’ Motion for an Order Pursuant to Section 363(a) and 105(a) of the BankruptcyCode Authorizing Implementation of Retention Plan” filed by Galey & Lord, Inc. on May 1, 2002with the US Bankruptcy Court for the Southern District of New York.

The Retention Program is designed to provide the Critical Employees with competitivefinancial incentives, among other things, (a) to remain in their current positions with theDebtors through the effective date (the “Emergence”) of a plan or plans of reorganization inthese cases, (b) to assume the additional administrative and operational burdens imposedon the Debtors by these cases, and (c) to use their best efforts to improve the Debtors’financial performance and facilitate the Debtors’ successful reorganization.

The Retention Program includes six separate components: (a) a performance incentive plandesigned to provide performance incentives to key management employees; (b) a stay bonusplan designed to ensure the continued employment of certain key management through thecompletion of the Debtors’ restructuring; (c) an emergence bonus plan designed to providean additional incentive to the Debtors’ CEO, who is particularly essential to the implemen-tation of the Debtors’ restructuring plan, through the confirmation process; (d) a severanceplan designed to ensure basic job protection for key management employees terminated otherthan for cause; (e) a discretionary transition payment plan designed to provide managementwith the ability to offer incentives to certain employees during a transition period at theend of which such employees would be terminated, in the event such circumstances arise;and (f) a discretionary retention pool designed to provide the CEO discretionary authorityto offer incentives to employees (including new employees) not otherwise participating inthe Stay Bonus Plan or the Emergence Bonus Plan.

RETENTION BONUS TIED TO PLAN CONFIRMATION AND INCENTIVE BONUSTIED TO ASSET SALE, EMERGENCE, AND DEBT RECOVERY

Excerpts from “Debtors’ Motion for an Order under 11 U.S.C. Section 105 and 363 Authorizing Imple-mentation of Key Employee Severance/Retention Program” filed by SLI, Inc. on October 3, 2002 withthe US Bankruptcy Court for the District of Delaware.

The Severance/Retention Program is a three-tier program that provides certain key em-ployees or their successors (the “Key Employees”) with an opportunity to receive a re-tention/stay bonus (the “Retention Payment”) and a severance payment (the “SeverancePayment”).

• Tier One Key Employee. The first tier (“Tier One”) covers a single employee, the ChiefExecutive Officer (the “CEO”) who has been designated as a corporate employee.Under the program, the Tier One employee would receive a retention payment of$350,000 and would be entitled to a severance payment of $150,000. The Tier Oneemployee’s Retention Payment shall be earned, due and payable in the followingmanner and on the earliest of the following events: (i) payment in full on terminationof the Tier One employee’s employment by the company ”without cause”; (ii) paymentin full on consummation of a plan of reorganization; or (iii) payment of 50% onconsummation of a sale of substantially all of the Debtors’ assets pursuant to 11 U.S.C.Section 363 in the GLE business line or the ML business line and the remaining 50%on consummation of a sale of the remaining business line or consummation of a planof reorganization. In addition to the Retention and Severance Payments, the TierOne employee would also be eligible to receive incentive compensation in an amount

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not to exceed $1.2 million. This additional Incentive compensation is earned basedupon the prepetition lenders’ aggregate percentage recovery. Receipt of the IncentiveCompensation would thus be directly tied to the amount of proceeds generated byone or more sales of assets of the Debtors’ respective business lines or distributionsunder a reorganization plan.

• Tier Two Key Employee. The second tier of the Severance/Retention program (“TierTwo”) covers twenty (20) employees or positions within the Debtors’ Corporate, ML,GLE and GLA business lines. Retention and Severance Payments to Tier Two employ-ees are based on position and are calculated as a percentage of a Tier Two employee’scurrent base salary. With respect to the Retention Payments, certain members ofthe Debtors’ executive management, including the Chief Financial Officer and theExecutive Vice Presidents, are eligible to receive payments ranging from 75% to 150%of base salary. Retention Payment shall be earned, due and payable in the followingmanner and on the earliest of the following events: (i) payment in full on termina-tion of the Tier One employee’s employment by the company ”without cause”; (ii)payment in full on consummation of a plan of reorganization; or (iii) payment of 50%on consummation of a sale of substantially all of the Debtors’ assets pursuant to 11U.S.C. Section 363 in the GLE business line or the ML business line and the remaining50% on consummation of a sale of the remaining business line or consummation of aplan of reorganization.

• Tier Three Key Employee. The third tier (“Tier Three”) of the severance/RetentionProgram provides for a discretionary pool of $50,000 to be reserved for certain essentialstaff members, which total includes any and all payments to such persons on accountof Retention and Severance Payments.

RETENTION BONUS TIED TO MINIMUM STAY AND INCENTIVE BONUS TIEDTO EMERGENCE, ASSET SALES, AND ENTERPRISE VALUE

Excerpts from the “Motion for Entry of Order Authorizing the Debtor to Implement and Honor a KeyEmployee Retention Program and Approve Severance and Separation Plans” filed by Anchor GlassContainer Corporation on October 25, 2005 with the US Bankruptcy Court for the Middle Districtof Florida.

The Debtor seeks to enter into retention agreements (the ”Retention Agreements”) with 81Key Employees (including the CEO) to retain the Key Employees and ultimately maximizethe value of the Debtor’s assets for the benefit of all parties in interest. Specifically, theDebtor seeks to minimize the turnover of Key Employees by providing incentives for thesepeople to remain in the Debtor’s employ and work toward a successful reorganization of theDebtor.

For 80 of the 81 proposed participants in the Retention Program, the retention incentiveconsists of cash retention payments at a percentage of base salary ranging from 20% to 65%the participants’ base pay payable at various critical points in the Debtor’s Chapter 11 case.The timing of these retention payments is contemplated as follows:

Tier # of % of Court 2/15/06 Emergence 6 Months TotalEmployees Base Approval Date Post KERP

Pay of KERP Emergence Payment

Tier I 7 65% 5% 15% 40% 40% 100%Tier II 9 65% 5% 15% 40% 40% 100%Tier III 11 40% 5% 15% 40% 40% 100%Tier IV 53 20% 5% 15% 40% 40% 100%

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For the remaining proposed Retention Program participant, CEO Mark Burgess, the reten-tion incentive consists of the following scenarios:

(a) in the event of a reorganization in which Mr. Burgess is retained as CEO of thereorganized Debtor, Mr. Burgess would be entitled to i) a retention payment of$500,000, which is equal to 83 percent of his base salary, (payable upon the Debtor’semergence from Chapter 11), plus ii) additional payments of $500,000 if the enterprisevalue of the Debtor equals or exceeds $300 million together with an amount equal toone percent of the amount by which the enterprise value of the Debtor exceeds $300million (both of these additional payments would be payable 6 months after Debtoremerges from Chapter 11), or

(b) in the event of a reorganization in which Mr. Burgess is offered to be retained as CEOof the reorganized Debtor with an employment agreement that is at least equivalentto the prevailing terms of employment in the open market for CEO’s of similarlysized companies with usual and customary CEO duties, but Mr. Burgess declines toaccept the offer, then Mr. Burgess would be entitled to i) a retention payment of$500,000, which is equal to 83 percent of his base salary, (payable upon the Debtor’semergence from Chapter 11), plus ii) additional payments of $500,000 if the enterprisevalue of the Debtor equals or exceeds $300 million, together with an amount equal toone percent of the amount by which the enterprise value of the Debtor exceeds $300million and 12 months severance pay (these additional payments would be payableupon the earlier of the termination of Mr. Burgess’ employment with the Debtor or6 months after the Debtor emerges from Chapter 11); or

(c) in the event of a reorganization in which Mr. Burgess is not retained as CEO of theDebtor, or in a situation where Mr. Burgess is terminated without cause prior toemergence to Chapter 11, or in which the Debtor’s offer of continued employmentto Mr. Burgess is not at least equivalent to the prevailing terms of employment inthe open market for CEO’s of similarly sized companies with usual and customaryCEO duties as discussed in (b) above, Mr. Burgess would be entitled to i) a retentionpayment of $600,000, which is equal to his base salary (payable upon the Debtor’semergence from Chapter 11), plus ii) additional payments of an amount equal to onepercent of the amount by which the enterprise value of the Debtor exceeds $300 millionand 18 months of severance pay (both of these additional payments would be payableupon the earlier of the termination of Mr. Burgess’ employment with the Debtor or6 months after the Debtor emerges from Chapter 11, with the exception of the casewhere he is terminated without cause prior to emergence from Chapter 11, wherebythe payment based on the enterprise value calculation would be paid within 30 daysof the emergence date); or

(d) in the event of a sale of substantially all of the assets of the Debtor, Mr. Burgesswould be entitled to i) a retention payment of $500,000, which is equal to 83 percentof his base salary, plus ii) additional payments of $500,000, if the gross sales priceof the assets of the Debtor equals or exceeds $300 million, together with an amountequal to one percent of the amount by which the gross sales price of the assets of theDebtor exceeds $300 million and 12 months severance pay (these additional paymentswould be payable upon the earlier of the termination of Mr. Burgess’ employmentwith the Debtor or 3 months after the completion of the sale of substantially all ofthe assets of the Debtor).

RETENTION AND INCENTIVE BONUS TIED TO DEVELOPING RESTRUCTURINGPROCESS (FILING A PLAN), OPERATION COMMITMENT, SPEED, AND EMER-GENCE

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Excerpts from the “Motion for an Order Authorizing Debtors to Implement a Key Employee RestructuringMilestone Incentive and Income Protection Program” filed by Exide Technologies on April 15, 2002with the US Bankruptcy Court for the District of Delaware.

The Incentive Plan provides incentives to Key Employees to remain with the Debtorsthroughout the Reorganization and to implement the changes needed to successfully com-plete the Reorganization. Under the Incentive Plan, participants can earn an additionalbonus equal to 10-100% of their annual base pay. Each program participant received 25%of their Incentive Plan bonus after completing the Debtors’ Five Year Business Plan. EachParticipant will receive the second 25% of their Incentive Plan bonus if and only if theymeet certain operation and restructuring commitments that have been assigned to eachparticipant. The final 50% of their Incentive Plan bonus will be paid to eligible employeeson the day the plan of reorganization is approved. However, the plan of reorganization mustbe approved on or before June 30, 2003 to qualify for the third phase of the payment. Thus,because a portion of a participant’s payout is contingent upon continuing service throughmost- and hopefully all-of the Reorganization process, the participant will be motivated tostay with the Debtors and to assist in the Debtors’ efforts during these Chapter 11 Cases.

INCENTIVE BONUS TIED TO FILING A PLAN, EMERGENCE, TARGET CASHFLOW AND WORKING CAPITAL, AND ENTERPRISE VALUE

Excerpts from the “Debtors’ Motion for an Order Authorizing the Implementation of the Calpine IncentiveProgram” filed by Calpine Corporation on April 6, 2005 with the US Bankruptcy Court for theSouthern District of New York.

The Emergence Incentive Plan (EIP) provides cash awards - payable only at emergence- to selected senior employees in the positions most capable of influencing the success ofDebtors’ ongoing business and reorganization efforts. The purpose of the EIP is to providea compelling and market-competitive cash incentive designed to encourage key manage-ment personnel to maximize the value of the enterprise while working toward a successfulreorganization of Debtors’ business. The plan is specifically geared toward rewarding thoseemployees who will devote their energies, knowledge, and creativity to consummating asuccessful plan of reorganization.

There are three principal benefits of the EIP. First, the plan is simple in concept and admin-istration. The structure of the EIP mirrors that of the incentive opportunities jointly devel-oped by Calpine and the Committee for Debtors’ chief executive officer and chief financialofficer. Second, the structure of the EIP motivates eligible employees to increase Debtors’enterprise value-directly benefiting all stakeholders-by tying EIP award level to value cre-ation. Compensation for eligible employees increases proportionate to the value createdfor Debtors and their creditors. Thus, the financial interests of Calpine, creditors and coremanagement are aligned. Third, the EIP is designed to provide a market-competitive long-term compensation opportunity for eligible employees. Accordingly, compensation levels foreligible employees are in line with long-term equity and cash-based opportunities at com-parable institutions. The Debtors have identified approximately 20 senior employees, whichinclude primarily executive vice presidents and a select group of senior vice presidents, whowill be eligible to participate in the Emergence Incentive Plan.

The Debtors seek also to implement a Management Incentive Plan (MIP) for approximately600 of Debtors’ employees who occupy positions critical to the operation of Calpine’s ongo-ing business as well as Debtors’ specific reorganization goals. At its core, the MIP will besimilar to the traditional bonus programs (the “Bonus Programs”) utilized by the Debtorspre-petition. The Management Incentive Plan will consist of awards as described below

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to be paid for performance for the calendar year 2006 and beyond. The MIP is designedto achieve two goals. First, the plan creates value by motivating employees to work effec-tively and expeditiously to achieve critical short term operational and financial goals-bothof which advance the interests of creditors and the estate in a timely emergence from re-structuring. Thus, the MIP meets the goal of aligning the interests of Calpine, its creditors,and its employees so that success is shared by all. Second, the plan provides market-competitive compensation opportunities for participants that are consistent with Calpine’shistorical practices while tempered by the financial constraints under which Calpine op-erates. Market-competitive compensation helps achieve the goal of preserving a criticalasset of the Debtors-their human capital-by promoting employee loyalty and morale andmilitating against attrition.

The first performance period will run from January 1, 2006 to June 30, 2006. Duringthis period, performance will be measured relative to four goals: (a) delivery of a BusinessPlan to the Board of Directors by June 1, 2006; (b) achievement of a target-adjusted cashflow that is calculated as an improvement to the DIP budget; (c) achievement of specificheadcount reductions and cost-cutting goals; and (d) the achievement of a working capitaltarget. The second performance period would run from July 1, 2006 to December 31, 2006.The performance measures for this period will be set forth in the Business Plan requiredto be delivered to the Board of Directors prior to the end of the first performance period.Payments under the MIP will only be made if performance objectives are achieved.

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