The Indian Parliament passed the Insolvency and Bankruptcy Code (IBC) in 2016 to strengthen and expedite the debt recovery process. Four years into its implementation, we take stock of how well the resolved companies have performed based on stock returns. Although it is too early to evaluate the business performance of the resolved companies by their new acquirers, stock returns provide a signal regarding the market expectations of future performance.
We find that larger firms generate very high returns after the resolution, while smaller firms do not do as well. We explore the reasons behind this dichotomy and the policy implications of this outcome. Given our findings, it appears that the recent move of the government to treat MSME insolvencies differently is a step in the right direction.
Analysing stock performance: According to the latest report from the Insolvency and Bankruptcy Board of India (IBBI), 3,774 resolution processes have been initiated until the end of March 2020. Of these, 714 have ended up in liquidation and the resolution plans in 221 cases have been approved. Of the 221 resolved firms, 23 are listed in one of the exchanges and are actively trading. To compare the stock performance of resolved firms with overall market performance, we build a portfolio consisting of stocks of resolved firms.
All the firms have the same weightage in the portfolio and each stock would be added in the portfolio on the date on which the resolution plan for the firm was approved. For example, if `100 is invested in each stock and the stock price of a firm is `20 on resolution date, then five units of those stocks are added to the portfolio on the resolution date. We use NAV (net asset value) to track the performance of the portfolio and start with a NAV of one on the date when the first resolution took place. As shown in Figure 1, the portfolio reached a NAV of 2.05 and grew by 105% in two and a half years, while Nifty dropped by 2% in the same period. We exclude Ruchi Soya from our portfolio because very few shares are available for trading.
We further segment the portfolios based on size—large firms and small firms. In the large-firms portfolio, we include all the firms that fall within the ‘Dirty Dozen’. Dirty Dozen are the 12 large accounts identified by the RBI that contributed to 25% of overall NPAs. The large-firms portfolio consists of seven firms as only seven out of those 12 firms are listed. The remaining 16 firms out of 23 listed firms that were resolved through the IBC process form part of the small-firms portfolio.
We observe in Figure 2 that the large-firms portfolio reached a NAV of 4.25 and grew by a whopping 325%, while Nifty generated −2% returns during the same period. In contrast, the small-firms portfolio grew only by 8.9% when the Nifty Midcap index dropped by 20%. While the small-firms portfolio performance is better than Nifty Midcap, it pales in comparison to the large differential between the large-firms portfolio and Nifty.
This indicates that resolution has been relatively more successful for large firms. One plausible reason is the availability of information and ease of valuation of large firms. A potential buyer will be able to make more informed decisions relating to participation in a bid, the maximum price and integration after the takeover. Smaller firms are relatively opaque, and hence it is hard for an outsider to engage in the bidding process with high-level information. Therefore, for every successful small-firm resolution, one can find many unsuccessful ones.
This raises questions about the efficacy of the one-size-fits-all resolution process followed so far. The IBC required small firms also to undergo the same insolvency process as large corporates. Apart from the issue highlighted above, this also led to a huge backlog of cases. As part of its Covid package for MSMEs, the finance ministry recently raised the threshold of default required to initiate insolvency proceedings from Rs 1 lakh to Rs 1 crore.
The government should consider making this provision permanent. The government, through its latest ordinance, has relaxed the restrictions on MSME promoters over bidding for their firms undergoing the insolvency process. These measures are likely to expedite the process of insolvency and unclog the backlog of cases pending at the NCLT. More discussion and research is required to understand what kind of insolvency framework works well for smaller firms.
Nithin Mannil And Prasanna Tantri
The authors are with the Indian School of Business