Vol 2 (2005) - Issue 6

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Weak-Form Tests of Market Efficiency in Corporate Debt Restructuring

Introduction

The concept of market efficiency has several distinct varieties. In an allocationally efficient (Pareto efficient) market any re-allocation that makes one or more individuals better off would result in at least one individual being made worse off. Operational efficiency in a market deals with the determination of commission fees, the degree of competition between financial market centres and among financial service providers. According to informational efficiency ‘a market is said to be efficient if it fully and correctly reflects all relevant information in determining security prices’.
Market efficiency is an essential issue for investment professionals and analysts of the market. Market efficiency depends on the types of information that are reflected in the securities’ prices. According to these types, the efficient market hypothesis has three versions: the weak form, the semi-strong form and the strong form, depending on the extent and type of the information that share prices reflect. The issue of market efficiency plays a crucial role in corporate debt restructuring procedures since companies’ share prices will be influenced by the information in the market and by how this information is absorbed in these share prices.
According to Norton, if a company decides to restructure its debt, it will be faced, inter alia, with three alternatives that are negotiated and implemented out-of-court: out-of-court reorganization, pre-packaged reorganization plans and pre-negotiated reorganization plans. An ‘out-of-court reorganization’ is the financial restructuring of the debt of the company by means of a contractual voluntary agreement without the intervention of any court or regulatory authority. According to the ‘pre-packaged reorganization plan’ the company designs and negotiates a settlement with its creditors without having the need to file a full court-supervised reorganization procedure. A ‘pre-negotiated’ plan is negotiated between the debtor and its creditors on an out-ofcourt basis and then is filed with a court to obtain the benefits of its approval, with no requirement for formal solicitation of votes.
In these methods of corporate debt restructuring, the issue of fluctuations in the prices of the shares of the firms may play a significant role in the whole restructuring procedure. The price of shares of a highly indebted company with the onset of financial distress is very likely to experience a decrease, while in the case where the company achieves a successful restructuring, share prices are expected to increase. An example of this tendency in share prices can be found in the pre-packaged reorganization plans. Such a plan contributes to the viability of the company and could increase the value of the shares that were bought at a steep discount after the default.
The case of Telecom Argentina SA, an Argentine listed company, provides a useful illustration. The company went through the restructuring of its debt by means of a pre-packaged deal. As noted by Olivares-Caminal, the share price started from AR$ 1.6 in October 2001 (six months prior to default), declining to AR$ 0.61 (announcement of moratorium on interests), before started rising again to AR$ 6.18 (date of the filing of the APE with the court for homologation), and finally to AR$ 8.42 (one month after achieving the restructuring). Similarly, the share prices of Net Servicos de Comunicacao SA increased, due to speculation that the firm was near the completion of its debt restructuring program.