Study on Post-IBC Firm Outcomes: Effectiveness Report

The Insolvency and Bankruptcy Code (IBC) of 2016 revolutionized the management of distressed businesses in India. By offering ‘resolution’, it allowed struggling entities to navigate financial distress and continue operations. This piece dives deep into the effectiveness of this resolution process, examining the real-world outcomes seven years post its inception. The IBC resolution process, while transformative, has its share of hurdles. Empirically, the resolved firms have fared significantly better post the resolution process. Participants in the survey radiated confidence in the resolution process, and interviews corroborated these findings. However, certain areas, especially around credit accessibility and stakeholder understanding, still call for attention. As the IBC continues to evolve, it remains to be seen how these challenges are addressed to ensure the optimal functioning and benefits of the resolution process.

Report of Study No Effectiveness of The Resolution Process: Fire Outcomes In The Post-IBC Period

The Insolvency and Bankruptcy Code, 2016 (IBC) has remarkably altered how distressed and defaulting businesses are handled by their stakeholders. One of the paths offered by the IBC is that of ‘resolution’, allowing a firm to continue as a going concern, despite the default. By focusing on the revival and continuity of financially distressed entities, the IBC seeks to preserve jobs, protect investments, and maintain the operational viability of such businesses. According to data from the Insolvency and Bankruptcy Board of India (IBBI), creditors have, on average, realised 32% of the admitted claims and 168% of the liquidation value in cases resolved under IBC. This data primarily reflects the outcomes in terms of financial recovery. However, it is essential to recognize that the success of resolution goes beyond these recovery figures. Now, as seven years have passed since the implementation of the legislation, it is an opportunity to review the functioning of firms that have undergone resolution under the IBC.

To understand the impact of the resolution process on the firms, a multipronged approach is adopted. The report looks at the performance of the firms both before and after the resolution process, to understand if the firms have been able to find their feet in the market. The report also compares the performance of the resolved firms against their peers by sector and size. This comparison tells us the magnitude of the gap and separates the changes that have arisen due to market forces, compared to changes brought about by better management.
Some of the key findings are:

• Average sales have shown an increase of 76% in three years since resolution. While the net margins continue to remain negative, the resolved firms have operationally broken even in the post-resolution period (operating margin of 4% as of T+3), which is a significant improvement from the pre-resolution period.

• There is around 50% increase in the average employee expenses in the three years post-resolution—indicating a higher employment intensity in the resolved firms (listed) in the post-resolution period. The total employment across listed firms have also shown a substantial increase in the post-resolution period.

• The trends indicate a significant increase of around 50% in the average total assets of resolved firms post resolution. This is coupled with 130% increase in the CAPEX, which indicate a build-up of tangible assets in the balance sheet of these firms in the post-resolution period.
• We find that there is convergence in the profitability ratios of the resolved firms with the benchmark averages in the post-resolution period (see Figure 2.5 for details).

• The trends in the market capitalization of listed resolved firms indicate a significant revival in the average market valuations in the post-resolution period, which is expected given the growth opportunities that will accrue to these firms post the resolution with the creditors. A similar trend is seen for the aggregate market valuation of all the resolved firms which has increased from around INR 2 lakh crore to INR 6 lakh crore in the postresolution phase. Overall, the results suggest that the market has priced and acknowledged the potential of these firms in the post-resolution period.

• Liquidity has improved in the post-resolution period by about 80%. The trends indicate a significant increase in the liquidity of the resolved firms in the post-resolution period. For instance, the current assets to current liability has improved from 1.01 in the year of bankruptcy to 1.83 in the third year post-resolution.

The report is divided into three parts. Part 1 provides the background and the methodology. The report provides quantitative and qualitative analysis of the functioning of the resolved firms. Detailed empirical analysis has been undertaken and utilizes metrics for profitability, margins, capital expenditure, leverage, cash flow, employment, market ratios etc. These metrics are employed to gauge their change over time and compare the resolved firms with their peers in the industry. The classes of peers utilized are (a) Industry and Size Decile Matched and (b) Propensity Score Matched (PSM).

The detailed methodology provides the scope and sources of data and the empirical methods employed. The event-window analysis method facilitates comparison with like firms before the bankruptcy filing and after the conclusion of the resolution process. The COVID-19 pandemic during this period was a source of distress to a large number of firms in the country. The regression controls for time and industry-fixed effects to accommodate its impact. The qualitative analysis involved survey and in-depth interviews. They were undertaken to provide the context for the empirical findings.

Part 2 of the report consists of findings from the detailed empirical analysis. The profitability and margins of the resolved firms saw a sharp uptick post the conclusion of the statutory process under IBC. This analysis holds true when com- pared with both industry size-decile matched and PSM firms. It is noteworthy that for all five profitability metrics, resolved firms showed a significant improvement when compared with PSM firms. Capital investments by firms indicate their investment in their future growth. For resolved firms, average capex saw an increase of approximately 130% in the three years post-resolution. There is a statistically significant increase in the Return on Capital Employed (ROCE) of resolved firms when compared to PSM firms in the post-resolution period. On liquidity and leverage, the situation is more nuanced. While liquidity and leverage ratios have improved, the change is not statistically significant in the post-resolution period for several metrics. For resolved firms, the interest coverage ratio is nearly at prebankruptcy levels, and the trend indicates convergence with average ratios seen by Industry and Size Decile Matched firms. Liquidity ratios, similarly, did not yield statistically significant results.

The issues relating to access to credit were taken up in the survey and interview to seek clarity on the subject. The uptake of labour by firms in the post-resolution period is also unclear. The data is limited to listed firms, and the firms show a total employee count nearly at pre-bankruptcy level. However, no significant difference can be drawn from the regression analysis. A trend analysis of Activity ratios that reflect operational functioning indicates an improvement in the activity ratio. Overall, we observe a statistically significant improvement in all the activity ratios in the post-resolution period except for the cash conversion cycle.

In this section, we also report the time value adjusted recovery rates along with analysis of industry-wise recovery rates and cost of resolution. For financial creditors, the highest recovery rates were observed in the Hotels and Restaurants and Construction industry and the lowest for Electricity, Gas And Water Supply. Whereas, for the operational creditors, the highest recovery rate was observed in the Wholesale & Retail Trade and Hotels and Restaurants industry and lowest for Transport, Storage And Communications Industry. One other service-based industry – Health and Social Work, showed high recovery rates. This challenges the traditional notion of asset-heavy industries having higher recovery rates. The role of auctioning might also have been crucial for price discovery for the service industry.

Part 3 discusses the findings of the survey and the interviews. Approximately 75% of those surveyed were happy with the post-resolution productivity levels. The participants identified access to financing as being a continuing problem, even post the resolution. Even when credit is available, the terms were not identified as being reasonable by those surveyed. Those interviewed indicated satisfaction with the working of the National Companies Law Tribunal. Post-resolution disputes with the Income tax, Customs and the RBI were flagged as being onerous, and a source of delay in obtaining clearances. Regarding the working of the Resolution Professionals, those interviewed felt that they needed skills for business and management.

Overall, based on the empirical analysis and the surveys conducted, we observe that:

• The resolved firms have significantly improved their performance across all important financial metrics in the post-resolution period. Several financial metrics of the resolved firms indicate a recovery to levels that is comparable to other healthy firms during the same period. Overall, the post-resolution activity and performance suggests an increase in the value addition by the resolved firms to the economy.
• Survey participants are largely satisfied with the resolution process and exuded confidence in their ability to meet the projected plans.
• Focus interviews validated the survey findings, however, it also revealed some room for improvements in the resolution process, especially with respect to the understanding of the resolution process across various stakeholders.

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