Provision of Management Incentives in BankruptFirms∗

Vidhan K. Goyal† Wei Wang‡

October 22, 2013

Abstract

We examine the use of key employee retention plans (KERPs) in bankrupt firms.Firms in Chapter 11 bankruptcy are more likely to offer retention and incentivebonuses to managers when creditors have greater control and when there is a greaterrisk of employee turnover. Incentives provided under such plans improve bankruptcyoutcomes along several dimensions: they increase the likelihood of emergence, re-duce bankruptcy duration, and result in fewer violations of the absolute priorityrule. We find no support for the view that KERPs enrich managers at the expenseof other stakeholders. Instead, they appear to be an efficient contracting solutionto the problem of retaining and incentivizing key employees in bankruptcy.

JEL classification: G30, G32

Keywords: key employee retention plans; incentive contract; Chapter 11; compen-sation; retention bonuses; creditor control; human capital

∗We acknowledge the helpful comments of Jiang Cheng, Casey Cheng, Richard Craswell, Sheng Huang,Ravi Jagannathan, Wei Jiang, Woojin Kim, Ken Lehn, Frank Li, Angie Low, Adair Morse, Paul Oyer,and Jano Zabojnik. We would also like to thank workshop participants at Concordia University, HongKong University, Hong Kong Polytechnic University, Monash University, Nanyang Technological Univer-sity, National Chengchi University, Queen’s University, and Yuan Ze University, and conference partic-ipants at the China International Conference in Finance, Northern Finance Association, Conference onEmpirical Legal Studies, NTU International Conference, and Asia-Pacific Journal of Financial StudiesConference. We thank Wenhan Lin, Matt Murphy, Remya Neela, and Nikhil Wadhwa for their excellentresearch assistance, and Lynn LoPucki, Parcels Inc., and various National Archives for their help withdata collection. Vidhan Goyal thanks the Research Grants Council for financial support (RGC Project#641110). Wei Wang thanks the CA Queen’s Center for Governance for financial support. c© 2013 byVidhan 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

Many bankrupt firms pay retention and incentive bonuses to their key employees to per-

suade them to stay with the firm through the restructuring process. These plans, com-

monly known as key employee retention plans or KERPs, occur in almost 39% of the

large public firm bankruptcies in the 1996-2007 period. In most plans, retention bonuses

are tied to a minimum stay of, on average, nine months. Often these plans provide addi-

tional incentives tied to the resolution of the bankruptcy (either through emergence from

bankruptcy or sale of assets), speed of restructuring, debt recovery, or specific targets

based on financial performance at plan confirmation. A typical plan covers about 2%

of the firm’s employees and pays bonuses that are between 30% and 70% of their base

salaries.2

KERPs are frequently pilloried as schemes through which managers enrich themselves.

Critics claim that retention bonuses reward failed and entrenched managers. Testifying

before the U.S. Senate Committee on the Judiciary, David McCall, a director with the

United Steel Workers of America, characterized retention 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

1Statement of Senator Edward Kennedy to U.S. Congress (151 Congress Record S1990, March 3,2005).

2For example, Worldcom Inc., filed for bankruptcy in July 2002 and offered 329 of its key employeesretention bonuses that paid between 35% and 65% of their annual salary. Half of each bonus was paidif the employees under the plan remained with the company for at least five months. The remainingamount was payable 60 days after confirmation of the plan of reorganization.

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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.”3

Defending these bonuses, companies take the position that retention plans prevent

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

common among distressed firms, are highly disruptive to the successful and expeditious

resolution of bankruptcy. Employee turnover results in a loss of continuity and firms

incur high search and training costs in finding replacements. Companies argue that the

costs incurred through delays in bankruptcy resolution and management changes could

be far greater than the cost of “pay-to-stay” bonuses to key employees. In short, the

bankrupt firms claim that KERPs are an efficient contracting solution to the problem of

high turnover in bankrupt firms.

In this paper, we examine these two starkly different views–the rent extraction versus

the efficient contracting–and in the process, offer the first detailed look at the structure

of retention and incentive bonus plans in bankrupt firms. We do this by assembling a

comprehensive database of KERPs offered in large public firms bankruptcies in the 1996-

2007 period; we perform a series of tests that examine the characteristics of firms that

adopt KERPs and the effect that KERPs have on bankruptcy outcomes.

3Statement of David McCall to the Senate Committee on the Judiciary on “Bankruptcy Reform” onFebruary 10, 2005. The media also has a negative view of retention bonus. See, for example, “WantSome 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 Spector andTom McGinty in The Wall Street Journal, January 27, 2012; and “Testing Chapter 11 Limits” by RachelFeintzeig and Jacqueline Palank in The Wall Street Journal, August 19, 2012.

2

We find that KERPs are common in bankrupt firms that exhibit a large amount of

creditor control. Specifically, bankrupt firms with court-approved creditors’ committees

and those with debtor-in-possession financing are more likely to pay retention and in-

centive bonuses. KERPs are also more common among bankruptcies in which there is

a greater likelihood of employee turnover. For example, KERPs are more frequently

adopted by firms headquartered in geographical areas where there are many other firms

in the same industry. In addition, KERPs are more frequently observed in industries in

which senior executives benefit from greater growth in cash compensation. In such indus-

tries, KERPs reduce the threat of employee turnover resulting from large pay disparities

at the bankrupt firm. Further, firms in distressed industries exhibit a lower likelihood

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

nities in such industries. We also show that firms in R&D intensive industries are less

likely to adopt KERPs presumably because of greater human capital specificity at such

firms. Overall, our findings on KERP adoptions are more consistent with the efficient

contracting view.

We do not find any evidence that KERPs are adopted by entrenched CEOs. The

only CEO characteristic that appears to be important in explaining CEO participation

in bonus plans is whether or not the CEO is a turnaround specialist. Such CEOs are

more frequently paid retention bonuses. None of the other CEO characteristics appears

to matter. Overall, there is no evidence that “entrenched” CEOs initiate these plans to

pay themselves large bonuses. However, their possession of specific skills seems to matter

to their retention.

Finally, we examine the effect of KERPs on bankruptcy outcomes. In our tests, we use

two measures of employees’ outside job options to identify exogenous variation in the use

of bonus plans. Our results show that KERPs increase the likelihood of a firm’s emergence

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from bankruptcy. However, we also find that the probability of emergence depends on

the specific nature of the incentives in these plans. Specifically, when key employees

are offered bonuses that are tied to firm reorganization or operating performance upon

reorganization, firms are more likely to reorganize. In contrast, when employees are paid

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

In examining the effect of KERPs on outcomes for creditors, we find that it is impor-

tant to distinguish between bonus plans that tie bonuses to minimum-stay or bankruptcy

plan confirmation from those that tie bonuses to specific outcomes. This distinction mat-

ters as KERPs in general do not materially improve Chapter 11 outcomes for creditors. In

contrast, firms that provide incentive bonuses spend significantly less time in bankruptcy

and exhibit a significantly lower likelihood of deviating from the APR. In short, although

both retention and incentive plans improve the likelihood of emergence, it is the adoption

of incentive plans that improves outcomes for creditors by shortening bankruptcy duration

and limiting stockholders’ ability to extract concessions from creditors.

This study makes several contributions to the literature on compensation in bankrupt

firms. Relative to KERPs, standard compensation contracts are less efficient, perhaps

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

creditors take control of the bankruptcy process. There is little existing research on how

compensation contracts change when firms file for Chapter 11. We also know little about

the extent to which bonuses paid to the senior management of bankrupt firms are tied

to the value of creditors’ claims. An exception is Gilson and Vetsuypens (1993) who

examine management compensation in a small sample of publicly traded firms that filed

for bankruptcy during the 1980s; they show that less than 20% of firms offered retention

bonuses, and even fewer firms tied these bonuses to creditor outcomes. We find that

it is becoming increasingly common for bankrupt firms to explicitly tie bonuses of key

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employees to minimum-stay or plan confirmation or to pre-specified milestones. The

incentives provided to executives of bankrupt firms are more closely aligned with the

interests of creditors. Furthermore, the fact that bankrupt firms provide retention and

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

the restructuring of troubled companies requires more decentralized decision-making.

Our paper is also related to the literature on the optimality of restoring incentives when

declining stock prices reduce option values to the extent that they become insensitive to

stock price changes. The practice of resetting exercise prices is highly controversial because

it presents similar issues as KERPs: although repricing options restores incentives and

retains executive talent, it can also be viewed as rewarding managers for poor performance

(see, for example, Chen (2004) and Acharya et al. (2000)). Senior management of firms

that have filed for bankruptcy similarly see a significant loss of compensation after the firm

files for Chapter 11. We show that firms find it optimal to pay retention and incentive

bonuses to key employees to restore their incentives when there is a significant risk of

employee turnover.

More broadly, this paper is related to the wider literature on the optimality of senior

management compensation practices (see Murphy (2013) for a recent review of this lit-

erature). This literature considers whether incentive contracts are set optimally, or do

CEOs control the pay-setting process and extract rents by increasing their own compen-

sation. This paper examines this question in the setting of bankrupt firms, where agency

problems are likely to be severe. We find no evidence for 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.

The rest of this paper is organized as follows. Section 2 provides a review of the lit-

erature on CEO compensation in bankrupt firms and presents our hypotheses. Section

5

3 describes our data sources and the construction of key variables, and provides a sum-

mary 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 the results

of the 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 and in-

centive bonuses in bankruptcies? How do bonus payments affect reorganization 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 show that the CEOs in these firms suffered large

personal losses. Moreover, their results highlight the fact that firms often rely on com-

pensation policy to deal with financial distress. In about 20% of the firms in Gilson and

Vetsuypens’ sample, CEO’s compensation is based on the outcome of the firm’s financial

restructuring. In about 17% of the cases, bonuses are tied to a minimum length of stay

with the firm, and in another 10% of the cases, compensation plans are restructured to

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

6

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

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

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

contrast, Kang and Mitnik (2009) examine 99 bankruptcies from the 1992-2005 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 study is unique in that it examines the retention and incentive bonus payments

offered to a wider 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 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 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. We find similar results with respect to the use of KERPs and

APR deviations. However, our focus is on understanding the use of KERPs in bankrupt

firms, the difference between retention only and incentive plans, and the effect that KERPs

have on a number of other bankruptcy outcomes.

The role of creditors in a firm’s decision to offer retention bonuses to its key employees

is critical to our understanding of how compensation contracts are set in Chapter 11

firms. If retention bonuses are a symptom of agency conflicts between managers and

7

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

managers. However, if KERPs 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 Preven-

tion and Consumer Protection Act of 2005 (BAPCPA)–introduced section 503(c) into the

Bankruptcy Code: a bankruptcy court is not to authorize payments to an ‘insider’ 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 survival of the

business, and (c) the retention payment is not greater than 10 times the average com-

pensation of a similar kind given to nonmanagement employees during the calendar year,

or, if no such payments were made, not greater than 25% of the amount paid to the key

employee in the previous year.

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

since 2005. Since the enactment of BAPCPA and the consequent difficulties in payment of

retention bonuses, most recent KERPs have been incentive plans. Bonus plans that are in-

tended to provide incentive compensation to management employees are subject to a more

liberal review process under Bankruptcy Code 363. In these performance-based pay plans,

firms offer bonuses that are contingent on employees achieving predetermined milestones.

These milestones are typically related to reorganization outcomes (reorganization versus

8

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

emergence. Given the new legislation restricting the payment of retention bonuses, it has

become even more important to distinguish the effects of retention plans from those of

incentive bonuses in improving creditor outcomes. Thus, we examine the effect of incen-

tive bonus plans on bankruptcy outcomes separately from the overall effect of KERPs on

outcomes.

3 Data Sources and Sample Description

3.1 Data

We begin with a sample of all of the Chapter 11 bankruptcy filings included in the UCLA-

LoPucki Bankruptcy Research Database (BRD) for the 1996 to 2007 period. 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 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.4 The final sample of 417 firms in Chapter 11 is

matched to Compustat to obtain firm-level financial data. Any information missing from

Compustat is filled in manually using information from 10-Ks (obtained from EDGAR).

4Financial 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 firms located near the headquarters of the Chapter 11 firms, and such location information isonly available for U.S. firms. Of the nine firms headquartered outside the U.S., one is in Argentina, twoare in Canada, and another six are in Bermuda.

9

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.5 The court documents related

to KERP motions and approvals are obtained from bankruptcy courts (mainly through

their respective Public Access to Court Electronic Records (PACER) websites).6 The

court documents provide detailed information on KERPs, including the identity of the

key employees covered, the purpose of the retention program, bonus amounts, and other

plan details. We provide examples of motions and orders approving KERPs for firms in

Chapter 11 in Appendix A.

The BRD and Bankruptcydata.com are our primary sources for basic information

about bankruptcy filings, including the type of filing, the outcome of the Chapter 11 pro-

cess, and the months spent in restructuring. Bankruptcydata.com also provides reorgani-

zation and liquidation plan summaries 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 summary is not available in this database, we obtain

the information from the relevant 8-K filings, the reorganization and liquidation plans

from PACER, or 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.

5The 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.”

6Every 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.

10

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 in the three years before the Chapter 11 filing, bur before the KERP

approval. In cases of CEO changes, we determine whether new CEOs are internal pro-

motions or external hires. Through a perusal of news articles about 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.

3.2 Summary Statistics

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

an annual distribution of all of the 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 the 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,

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

We classify KERPs into those that offer only retention bonuses and those that offer

incentive bonuses (often with retention payments). Retention bonuses are a common

feature of the bonus plans adopted by firms in bankruptcy. Of the 164 KERPs in the

sample, 145 (88%) are either retention only plans or incentive plans combined with a

11

retention feature. Incentive plans are offered by 97 of the 164 firms that offer KERPs

(of these, 19 firms offer only incentive bonuses with no retention payments). There is a

dramatic decline in the use of retention-only 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

from retention bonuses to incentive bonuses.

Panel A of Table 2 presents the mean values of firm characteristics in the pre-filing year

for the whole sample and for the two sub-samples stratified by KERP adoption. Overall,

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 Chapter 11 firms are, as expected, substantially

overleveraged; their average total liabilities to assets ratio is 1.02 (the median is 0.92).

The industry-adjusted leverage ratio is 0.44, which indicates significant distress.7 In

addition to being overleveraged, these firms 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 industry 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. A comparison of the characteristics of

firms that adopt KERPs and those that do not shows that KERPs are adopted by larger

and better performing firms with greater institutional ownership. In addition, KERPs are

adopted by firms in industries that are not “distressed” and exhibit lower R&D intensity.

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

Chapter 11 filings are pre-packaged bankruptcies in which reorganization plans are nego-

tiated and voted on by shareholders and creditors before bankruptcy filing.8 Due to the

7We obtain the industry-adjusted characteristic by subtracting the median-industry characteristic(based on the two-digit SIC) from the comparable characteristic for each firm.

8The simultaneous filing of both the bankruptcy petition and the reorganization plan considerablyshortens the time that companies spend in bankruptcy. Tashjian et al. (1996) provide descriptive infor-

12

less complex nature of pre-packaged filings, KERPs are much less likely to be adopted

in these cases. About 67% of the bankrupt firms obtain debtor-in-possession financing.

Roughly 44% of the bankruptcies are filed in Delaware. Creditors’ committees are com-

mon; about 85% of firms have such committees approved by court. In contrast, official

equity committees are less common and exist in only 11% of bankruptcy cases. KERPs are

more common among firms that have DIP financing in place and an approved creditors’

committee, which are both measures of the strength of creditor control of the bankruptcy

process.

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

claimant (often equity) receives some payment even though senior claimants are not paid

in full. Many bankruptcy scholars argue that such deviation from APR happens because

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 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 first calculate the recovery to each debt class by

adding up the values of cash and new securities each class receives. Except for debt (for

which we use the face value), the securities are valued using traded prices that most accu-

rately post date the firm’s emergence from bankruptcy. These traded prices are obtained

from various sources, including CRSP, Bloomberg, Datastream, and the Bankruptcy Data-

Source. An APR deviation is deemed to have occurred if equity holders receive a payment

before other senior claims are paid in full.9 We use this information about APR deviation

mation on a sample of 49 pre-packaged Chapter 11 bankruptcies and show that pre-packaged bankruptciesincur lower direct costs of bankruptcy, result in higher debt recoveries than traditional Chapter 11 filings,and the distressed firms spend less time in bankruptcy.

9See, for example, Eberhart et al. (1990), Betker (1995), and Jiang et al. (2012).

13

to construct an indicator variable that takes a value of one if there is any APR deviation,

and zero otherwise. APR deviations are not commonplace and occur in about 17% of

bankruptcy cases.10 Interestingly, we find that the occurrences of APR deviations are

significantly less common in firms with KERPs than in those without (7% versus 23%).

Panel C shows the mean of the three governance variables and CEO characteristics.

The average board has seven members, 71% of whom are classified as independent direc-

tors. 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 four 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 three years before Chapter 11 filing). A little more

than half of the new CEOs are external hires. About 20% (49 of 237) of the new hires

are turnaround specialists. Comparing the two sub-samples of firms, we find only board

size appears to be different; specifically firms with KERPs tend to have larger boards.

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

as a reorganization if 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 piecemeal

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 time

spent in bankruptcy is 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

10The literature shows that APR deviations were much more common in the 1980s and in the 1990s(Weiss, 1990). Our observation of the decline in APR violations is consistent with the findings of Bharathet al. (2010).

14

(the median is 13.5 months).11 Firms that adopt KERPs tend to spend more time in

bankruptcy restructuring regardless of outcomes.

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

2% of the firm’s employees. Most plans classify employees into three tiers: the highest

tier consists of a few top managers who are paid larger bonuses, whereas the lowest tier

consists of a greater number of managers who are paid smaller bonuses. In the highest

tier, a median of six employees receive retention bonuses that represent about 75% of

their salaries. In the lowest tier, a median of 46 employees receive retention bonuses that

represent about 30% of their salaries.

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 frequently included.

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 nine months following the KERP initiation

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

bonuses if the employee stays until the 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-

11The average duration of bankruptcy decreases from 21 months at the beginning of our sample periodto 12 months in the more recent 2004-2007 period. The decrease in average bankruptcy duration is alsoevident in the literature. Frank and Torous (1994) report an average duration of 30 months during the1983-1988 period; Bharath et al. (2010) report an average duration of 18 months for the more recentperiod. Firms that reorganize spend less time in bankruptcy than firms that are liquidated or acquired.

15

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. The incentives

tied to firm liquidation overcome the inherent biases in the Chapter 11 process toward the

continuation of unprofitable firms as documented by Hotchkiss (1995). 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 (or 2.6% of cash on the

balance sheet and DIP financing amount), appear small when compared to professional

legal fees paid in bankruptcy, which, according to LoPucki and Doherty (2004), could be

as large as 2% of a firm’s assets (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. Ayotte

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

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

16

influence of creditors in Chapter 11 should be associated with an increase in the adoption

of KERPs. We employ two measures of creditor power: (a) the presence of an unsecured

creditors’ committee, and (b) the presence of debtor-in-possession financing.

In many Chapter 11 cases, debtor’s seven largest unsecured creditors are appointed to

the official unsecured creditors’ committee according to U.S. Bankruptcy Codes Section

§1102. The appointment to an official creditors’ committee allows unsecured creditors

access to material information about the company and enhances their direct involvement

in the debtor’s restructuring. Therefore, the existence of a creditors’ committee indicates

that unsecured creditors have a direct 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 man-

agers of hedge funds often seek representation on a creditors’ committee to influence the

bankruptcy process. We expect more active creditors to object to bonuses if they do not

improve bankruptcy outcomes. Therefore, if KERPs are adopted by firms with greater

creditor control, then it is most likely optimal for creditors to have the firm pay the

bonuses to key employees.12

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

Skeel (2003) argues that DIP financing has become a new tool of governance by senior

creditors in Chapter 11. Through DIP financing, creditors gain a significant amount of

control through loan agreements and covenants, and subsequently exert control over the

restructuring decisions as well as over the governance of bankrupt firms.

12Unsecured creditors’ committee are often formed in complex cases, and cases where information onasset valuation is opaque. In unreported analysis we find creditors’ committees are less likely to be formedin pre-packaged cases and more likely to be formed in firms that are large and have lower cash balancesand tangible assets. We acknowledge the possibility that the existence of a creditors’ committee couldbe, to some extent, a proxy for the complexity of the case.

17

Table 4 presents the results of the 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 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 in those without such a committee, keeping all of the other variables at their means.

Similarly, the probability of KERP adoption is 21% higher in firms that receive DIP

financing than in those that do not.

If firms optimally adopt retention and incentive bonus plans to induce employees to

stay with the firm, then they are more likely to do so when there is a greater threat of

employees leaving the firm. We therefore include variables that measure employees’ out-

side job opportunities in Column (2). Firms facing a greater threat of employee turnover

are more likely to adopt KERPs.13

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

13Previous research shows that bankruptcies result in a significant increase in CEO turnover. Thisshould also be correlated with high turnover among non-CEO executives. Fee and Hadlock (2004) showthat non-CEO turnovers are elevated at the time of CEO dismissals.

18

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

portunities, and suffer smaller wage losses when switching employers, whereas bankrupt

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

or incentive bonuses. Further, for an employee, the opportunity costs of not switching

employer are high when the firm is in bankruptcy, due to the negative effect on his repu-

tation of being associated with the failed firm. The firm has to compensate the manager

for this adverse effect particularly when there are abundant outside job opportunities. In

our main tests, 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 of the sample firm’s

headquarter, and zero otherwise.14 However, our results are invariant to alternative cut-

offs, based on both the number of same industry firms and the size of the geographic area.

In addition, we find similar results after scaling the number of same industry firms in the

same geographic region by the total number of firms in the same industry nationwide.

The positive and statistically significant coefficient for the ThickEmplMarkets vari-

able is consistent with the argument that the availability of alternative job options in-

creases retention bonus payments. The effects are also economically large. The probabil-

ity of KERP adoption is 40% higher for bankrupt firms operating in thick employment

markets than for firms not operating in such markets.

As the second proxy for employees’ propensity to change jobs, we include the me-

dian industry cash compensation growth (IndCompGrowth).15 A higher growth in cash

compensation in comparable firms implies greater pay disparities between the pay of exec-

14The distance of a company’s headquarter from all other Compustat firm headquarters is estimatedusing the Haversine formula. See http://en.wikipedia.org/wiki/Great-circle distance.

15We focus on cash compensation rather than on total compensation because equity-based compen-sation is less relevant for firms in bankruptcy. Also, cash compensation is tied much more closely toshort-term performance targets. Cash compensation is estimated as the average salary and bonus pay-ments for the top-five paid non-CEO executives. We use firms in Execucomp to calculate the annualgrowth rate of cash compensation of senior executives for all 2-digit SIC industries (excluding the firm inquestion).

19

utives 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

industry cash compensation growth increases the probability of KERP adoption by about

5%.

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

distress. Shleifer and Vishny (1992) show, in the context of asset sale markets, that

the ease with which firms can sell assets drops when an entire industry is in distress.

Similarly, employees would find fewer alternative employment opportunities when other

firms in the industry are also in distress. As such, the presence of 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. The results suggest that firms

operating in distressed industries have a marginally lower likelihood of using KERPs.

The specificity of human capital should also affect a firm’s incentives to offer retention

bonuses. We therefore examine if industry R&D intensity, which we take to be a proxy for

human specificity, affects the adoption of KERPs.16 Greater specificity of human capital

would result in employees having fewer outside options as their skills are less transferable.

This would suggest a lower likelihood of KERPs in R&D intensive industries. However,

greater firm specificity also increases the value of employees to the existing firm, which

makes it more likely that KERPs will be adopted. Thus, the effect of industry R&D

intensity on the likelihood of KERPs is ambiguous. The evidence is more supportive of

16We define an industry to be R&D intensive if the median R&D to assets ratio of the industry isgreater than 1%. We do not use firm-level R&D intensity as this information is available only for a smallset of sample firms.

20

the former than the latter as we find that KERPs are less common in R&D intensive

firms.

We next examine whether KERPs are a reflection of agency problems. If so, then

we should observe that firms with weaker boards and more powerful CEOs should have

a greater propensity to adopt 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 because larger boards often

appear in firms with greater complexity, which, in turn, could explain why firms with

larger boards are more likely to adopt KERPs.17

All of the regression specifications control for firm size, industry-adjusted leverage and

operating performance, institutional ownership, the pre-packaged bankruptcy indicator,

the Delaware filing indicator, and industry-fixed effects.

We find that KERPs are more likely in larger firms. A one standard deviation change

in firm size increases the likelihood of KERP adoption by 8% (with all other variables

held at their means). This positive relation perhaps reflect the fact that large firms are

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

KERPs are more likely in profitable firms. If profitability is correlated with the quality

of management, then this would suggest that KERPs are optimally used by firms with

higher quality managers. These managers perhaps have better outside employment op-

tions. The positive sign on leverage suggests that KERPs are more common among firms

that face financial distress than in firms that face economics distress.18

17For example, Coles et al. (2008) and Lehn et al. (2009) show that complex firms have larger boards.18Lemmon et al. (2009) employ leverage and profitability as a proxy for financial distress as opposed

to economic distress.

21

When firms enter bankruptcy, many institutional investors vote with their feet and

exit (Parrino et al., 2003). However, other institutional investors stay invested. When

such remaining ownership is high, we expect these firms to be better governed and to be

of higher quality. The positive coefficient on institutional ownership is consistent with the

explanation that KERPs are being adopted by better quality firms. The coefficient for

the pre-packaged filing indicator is negative and statistically significant at the 1% level.

The estimates suggest that firms opting for pre-packaged bankruptcies have an 18% lower

likelihood of KERP adoption than those choosing regular bankruptcies. The coefficient

for the Delaware dummy is positive but not robust.

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

firm’s decision to offer incentive bonuses (with or without retention bonuses) separately

from its decision to offer retention-only bonuses. These results, while generally consistent

with those presented above, offer a few interesting variations. First, firms are more likely

to adopt incentive plans when there is a creditors’ committee and when lenders provide

DIP financing. Retention-only plans do not appear to feature prominently in creditors’

agendas as both measures of creditor power are insignificant in explaining retention-only

plans. Second, only two variables, Pre-packaged and ThickEmplMarkets are significant

in explaining the choice of retention only plans. This suggests that local labor market

conditions are important in a firm’s decision to offer retention bonuses. The negative

coefficient on the pre-packaged bankruptcy indicator is expected as a retention plan is

less likely when a bankruptcy is resolved relatively quickly.

22

4.2 Explaining Plan Features

Table 6 presents the Tobit estimates from the regressions that relate bonus plan features

to various 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 or

the sum of cash balance and the amount of DIP financing received.19 Columns (1) to (4)

present the results for retention bonuses, whereas Columns (5) to (8) present the results

for incentive bonuses.

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

that 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 or incentive bonuses and the bonuses at such

firms make up a larger fraction of their assets. In other words, greater creditor control is

associated with higher retention or incentive plan payments. ThickEmplMarkets posi-

tively affect the plan sizes and plan costs for the payment of retention bonuses but not for

incentive bonuses. In contrast, IndCompGrowth marginally affects plan sizes and costs

for incentive bonuses but not for retention bonuses.

19The motions and orders for KERP adoption provide either a 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 the Chapter 11 filing. The percentage bonus paid to top tierexecutives in our sample ranges between 4% and 200% for retention plans, and between 7% and 844%for incentive plans, respectively.

23

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 such problems,

then we would expect to see that entrenched top executives as part of retention plans.

Furthermore, weak governance would 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 participation in

KERPs.

Table 7 presents the logit estimates predicting CEO participation. In Columns (1) to

(3), we examine CEO participation in all KERPs regardless of whether they are retention-

only plans, 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 zero otherwise. In Columns (4) to (6), we focus on CEO

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

on these plans. Here, the dependent variable takes a value of one if the CEO receives an

incentive bonus, and 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 Columns (2) and (5), we consider CEOs who are promoted in-

ternally 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 of the CEO characteristics, only

turnaround specialists have a marginally higher likelihood of receiving retention or incen-

tive bonuses. This reflects the importance of turnaround specialists to distressed firms.

24

Overall, the findings refute the perception that KERPs are used to enrich failed man-

agers. Among the governance variables, only board size predicts CEO participation in

KERPs. As discussed above, greater board size most likely reflects bankruptcy complex-

ity, 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 is associated with a greater likelihood that CEOs are covered by KERPs. The sta-

tistical significance on ThickEmplMarkets is predictable as CEOs tend to have greater

mobility than other lower level managers and have alternative job opportunities.

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 selection and participation in KERPs.

5 KERPs and Bankruptcy Outcomes

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

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

the use of KERPs improves creditor welfare. To test this hypothesis, we consider three

bankruptcy outcomes: (1) bankruptcy resolution (emergence versus liquidation), (2) time

spent in bankruptcy, and (3) deviations from APR.

In most Chapter 11 bankruptcy filings, creditors prefer the firm to reorganize as recov-

ery for creditors is often greater when firms reorganize than when they liquidate possible

because growth options can be retained in emergence. However, in some cases creditors

may prefer firms to liquidate because liquidation maximizes recoveries for creditors.

25

We expect creditors to prefer expeditious resolutions as costs in Chapter 11 are a

function of the time spent in bankruptcy.20 Creditors, of course, would prefer fewer

deviations from APR, all else being equal, as any deviation is a cost that the bankruptcy

process imposes on creditors.

The predictions for how “pay-to-stay” bonuses affect outcomes are complex and nu-

anced. Therefore, it is important to distinguish between retention bonus plans that com-

pensate managers who stay at the firm until a specified date (or until plan confirmation)

from plans that offer incentive bonuses tied to specific milestones. For example, there are

no clear predictions on how the provision of pay-to-stay bonuses will affect emergence as

in both reorganizations and liquidations, creditors will want key employees to stay at the

firm until the bankruptcy is resolved. Similarly, it is unclear how retention bonuses affect

the time spent in bankruptcy. Bonus plans that tie bonuses to minimum stay provide

no direct incentives to reduce the time spent in bankruptcy. And, bonuses tied to plan

confirmation may result in less time spent in bankruptcy if managers attach high enough

discount rates to the bonus payments.

In contrast, the predictions are relatively clear for incentive bonus plans. 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. As 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.

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;

20LoPucki and Doherty (2004) provide estimates suggesting that doubling the time a case remainspending increases fees by about 57%.

26

the firm will gradually reduce bonus payments as the plan confirmation date moves into

the future. Finally, 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.

Estimating the effect of KERPs on outcomes is not straightforward, as firms optimally

determine when to use bonus plans. A firm’s decision to use a KERP as a function of the

X variables is specified below.

KERP ∗i = Xiβ + εi (1)

A firm adopts a KERP 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)

Econometrically, a selection problem amounts to a non-zero correlation between the

error disturbances in equations (1) and (3). The estimated coefficient µ̂ is likely to be

biased. The direction of the bias would depend on the sign of the correlation.

To identify the outcome models, we rely on two instrumental variables that predict

the adoption of KERPs but not the bankruptcy outcomes. Both of our instruments are

27

related to employees’ outside options. As discussed in Section 4, KERPs are frequently

adopted in bankrupt firms with greater local employment options for employees (measured

by ThickEmplMarkets). We do not expect a geographic concentration 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 compensation increases the

likelihood of KERP adoption. However, with this variable, there is a concern that in-

dustry cash compensation growth may be correlated with industry outcomes which may

somehow affect bankruptcy outcomes. Thus, in discussing our results, we place a greater

emphasis on our first instrumental variable (ThickEmplMarkets) than on the second

(IndCompGrowth).

The Zi variables include firm size, leverage, profitability, institutional ownership,

the pre-packaged bankruptcy indicator, Delaware-bankruptcy indicator, the industry-in-

distress indicator, R&D intensive industry indicator, the secured debt scaled by assets,

an official equity committee indicator, and variables measuring creditor control. All of

these variables are known to affect bankruptcy outcomes (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 the Zi variables.

With binary-outcome variables and binary-endogenous explanatory variables, we esti-

mate a bivariate probit model (see Evans and Schwab (1995) and Woolridge (2002) Chap-

ter 15.7.3) using the Maximum Likelihood estimation method. In addition to reporting

the coefficients for the outcome regressions, we provide the p-values for the Likelihood

Ratio test for the null of the correlation of the error terms from the selection equation

28

(1) and the outcome equation (3) being zero. The test is equivalent to testing the exo-

geneity of KERPs with respect to bankruptcy outcomes as a nonzero correlation indicates

endogeneity.

Given the differences between retention-only plans and incentive plans that addition-

ally provide bonuses tied to specific milestones, we discuss results for the effect of KERPs

on outcomes in Section 5.1. In Section 5.2, we examine how incentive bonuses affect

bankruptcy outcomes.

5.1 KERPs and Bankruptcy Outcomes

Table 8 presents the results from both the logit and bivariate-probit regressions that

examine how KERPs affect each of the three bankruptcy outcomes. Columns (1) and (4)

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 coefficient on the KERP dummy is positive and significant

in both the logit regression and the instrumented bivariate probit regressions suggesting

that KERPs positively affect the likelihood of emergence from bankruptcy.

Columns (2) and (5) examine the effect of KERPs on bankruptcy duration. We define

bankruptcies that take longer than a year as lengthy and those resolved in less than a

year as quick. Thus, the dependent variable in these columns is an indicator variable that

takes a value of one for lengthy bankruptcies, and zero otherwise. The logit results shown

in Column (2) suggest that KERPs are associated with a longer duration of bankruptcy.

However, once we control for endogeneity, the bivariate probit results shown in Column (5)

suggest no relation between KERPs and bankruptcy duration. The positive association

29

between KERPs and duration is most likely a result of KERPs being adopted in more

complex cases that take longer to resolve.

Columns (3) and (6) examine the extent to which KERPs mitigate APR deviations.

We find a negative coefficient that is statistically significant at the 1% level in the logit

regressions reported in Column (3). However, the bivariate probit results in Column (6)

show no relation between KERPs and deviations from APR. This difference suggests that

the negative relation between KERPs and APR deviation is perhaps the result of KERPs

being adopted in firms where shareholders have little ability to extract concessions from

creditors.

Overall, there is some evidence that KERPs increase the probability of emergence and

no evidence that they affect bankruptcy duration or APR deviations.

5.2 Incentive Plans and Bankruptcy Outcomes

As much of the criticism of KERPs is, in fact, criticism of retention-only plans, we next

examine the effects of incentive bonus plans relative to the effects of no bonuses or reten-

tion only bonuses. As discussed above, incentive bonuses are often contingent on a firm

achieving a certain outcome or 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.

Table 9 examines the effect of incentive bonus plans on the three bankruptcy outcomes.

The incentive indicator takes a value of one if a plan includes incentive bonus payments

to key employees, and zero otherwise. As before, the regressions control for the firm and

bankruptcy characteristics that are important in determining outcomes.

30

The bivariate probit estimates reported in Column (4) of Table 9 confirm this pre-

diction. The likelihood ratio test rejects the null hypothesis that the correlation of the

residuals from the selection equation and the outcome equation is zero. The positive

treatment effects indicate that incentive plans increase the probability of emergence.

In Columns (2) and (5), we examine how the presence of incentive bonus plans is

related to time spent in bankruptcy. Column (2) suggests that the total effect of incentive

plans on duration is insignificant. However, after controlling for selection, the estimates

in the treatment regression show that the use of incentive bonuses significantly reduces

time spent in bankruptcy. The effect of incentive plans on bankruptcy duration is in

stark contrast with the results shown in Column (5) of Table 8 where we examine all of

the plans (including the retention-only plans). The likelihood ratio test rejects the null

hypothesis for the exogeneity of incentive plans. Our results suggest that incentive plans

are often adopted in cases that are lengthy ex ante. Incentive bonus plans work in the

interests of creditors by reducing time spent in reorganization.

Column (3) and (6) show the effect of incentive bonus plans on the likelihood of APR

violation in Chapter 11. Consistent with our prediction, we find that the coefficient on

the incentive plan indicator is significantly negative, although the significance levels are

low.

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

employees improve Chapter 11 outcomes in three dimensions, namely a higher likelihood

of a firm’s emergence from bankruptcy, less time in bankruptcy, and a lower likelihood of

APR deviation.

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 always

31

statistically significant.21 We expect leverage to positively affect the probability of emer-

gence because high leverage indicates that the firm suffers from financial, rather than

economic, distress. In addition, creditors of highly leveraged 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 these bankruptcy petitions 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) of Tables 8 and 9. The

Delaware filing dummy is negatively associated with emergence.

We find that the presence of a creditors’ committee is associated with a longer time

spent in bankruptcy. Perhaps complex bankruptcies are associated with the presence of

a creditors’ committee and this complexity increases time in bankruptcy. As expected,

pre-packaged bankruptcies are resolved more quickly. Higher levels of secured debt are

associated with faster resolution, probably because secured lenders are more concentrated

and thus there are fewer coordination problems. The only other variable that is significant

in 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 deviations

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

reported in Tashjian et al. (1996).

21Larger 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; Lemmon et al., 2009).

32

5.3 Plan Objectives and Bankruptcy Resolution

Table 10 presents the results for the test of whether specific objectives in retention and

incentive plans differently affect the probability of emergence. We focus on those plan ob-

jectives that 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, as reten-

tion bonuses are based on a minimum stay or on the length of stay until plan confirmation

(which could be either a reorganization or liquidation).

Columns (3) to (5), 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 a 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 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.

The results presented in Column (5) show the effect of incentive bonus plans that link

incentive bonuses to targets based on firms’ EBITDA upon emergence. 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

33

stronger findings on the effect of incentive plans on outcomes suggest that incentive con-

tracts help firms achieve their desired performance objectives.

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. A common

preception is 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 in Congress.

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

retention plans are necessary 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, have strong explanatory power for 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, our evidence suggests that KERPs are more likely to be used when creditors

have strong influence 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 provide retention only bonuses and

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

do not materially improve creditors’ overall payoffs, plans that provide incentive bonuses

34

significantly increase the likelihood of a firm’s emergence, and 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. In contrast, when incentive bonuses are tied to asset

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

Overall, our evidence casts doubt on claims that KERPs are adopted because creditors

are ineffective in preventing managers from enriching themselves through the payment of

these bonuses. In fact, we find that creditor control is critical in the payment of retention

and incentive bonuses and that such plans generally improve outcomes for creditors.

35

References

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38

Table 1: Use of KERPs in Chapter 11

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

4 provide the annual distribution of two different types of KERPs – plans that provide only retention

bonuses and plans that provide both retention and incentive bonuses. The initial sample includes all of

the 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 either dismissed or 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 of Chapter 11 filing.

KERPs Featuring

Year Total KERP Retentions IncentivesFilings Adopted Only

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

1996 14 (3.4%) 4 (29%) 3 (21%) 1 (7%)1997 13 (3.1%) 5 (38%) 3 (23%) 2 (15%)1998 24 (5.8%) 6 (25%) 5 (21%) 1 (4%)1999 36 (8.6%) 15 (42%) 8 (22%) 7 (19%)2000 72 (17.3%) 22 (31%) 9 (13%) 13 (18%)2001 82 (19.7%) 30 (37%) 11 (13%) 19 (23%)2002 67 (16.1%) 25 (37%) 10 (15%) 15 (22%)2003 45 (10.8%) 23 (51%) 6 (13%) 17 (38%)2004 27 (6.5%) 15 (56%) 7 (26%) 8 (30%)2005 19 (4.6%) 10 (53%) 5 (26%) 5 (26%)2006 11 (2.6%) 6 (55%) 0 (0%) 6 (55%)2007 7 (1.7%) 3 (43%) 0 (0%) 3 (43%)

Total 417 (100.0%) 164 (39%) 67 (16%) 97 (23%)

39

Table 2: Summary Statistics

The table presents the summary statistics of our sample firms, and of the sub-sample based onwhether KERPs are adopted. Panel A presents the mean values of firm characteristics in the yearbefore bankruptcy. Panel B provides the summary statistics of bankruptcy-related variables. PanelC summarizes governance and CEO characteristics, and panel D tabulates the bankruptcy outcomesand presents the means of time to resolution, in months, for each of the three outcomes. The lastcolumn shows the p-values from the t-test on the difference between firms with KERPs and firmswithout KERPs. The initial sample includes all Chapter 11 filings by U.S. public firms with bookassets above $100 million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcycases that were dismissed and those that were still pending as of December 31, 2008. We alsoexclude financial firms, utilities, and firms headquartered outside the U.S. The financial and own-ership data are as of the year before the filing. The variables are defined in Appendix Table 1.

Variable All Firms KERPs No KERPs T-testN Mean Mean Mean P-value

Panel A: Firm Characteristics

Assets (in millions of 2008 dollars) 417 2040.36 3350.84 1190.87 0.005Leverage 417 1.02 0.99 1.03 0.426Industry-adjusted leverage 417 0.44 0.41 0.46 0.301ROA 416 0.01 0.04 -0.01 0.009Industry-adjusted ROA 416 -0.07 -0.04 -0.09 0.020Secured debt/assets 410 0.42 0.39 0.43 0.200Institutional ownership 417 0.27 0.34 0.22 0.000Industry in distress 417 0.17 0.13 0.19 0.069R&D intensive industry 417 0.37 0.30 0.42 0.010

Panel B: Bankruptcy Characteristics

Pre-packaged 417 0.29 0.13 0.40 0.000Delaware 417 0.44 0.46 0.43 0.464DIP financing 417 0.67 0.83 0.57 0.000Creditors’ committee 417 0.85 0.98 0.76 0.000Equity committee 417 0.11 0.14 0.09 0.117Reorganization 417 0.60 0.61 0.59 0.673APRDev 417 0.17 0.07 0.23 0.000

Panel C: Governance and CEO Characteristics

Board independence 392 0.71 0.72 0.71 0.547Board size 392 7.67 8.34 7.24 0.000CEO-chairman 393 0.50 0.50 0.50 0.950CEO-founder 390 0.15 0.15 0.15 0.874CEO age 370 53.05 53.27 52.91 0.629CEO tenure 402 4.00 3.87 4.08 0.698CEO incumbent 405 0.41 0.38 0.43 0.288CEO internal hire 404 0.24 0.26 0.23 0.466CEO external hire 404 0.35 0.36 0.34 0.631CEO turnaround specialist 404 0.12 0.15 0.10 0.132

Panel D: Bankruptcy Duration (in months) by Outcome

Reorganization 249 13.58 19.05 9.91 0.000Acquisition 46 18.06 21.69 12.90 0.004Liquidation 122 23.72 29.46 21.22 0.039

Total 417 17.04 21.83 13.93 0.00040

Table 3: Details of KERPs

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

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 0.24Total costs/(cash+DIP) (%) 129 5.25 2.45 79 4.00 1.69Maximum pool (in 2008 $ mill) 120 9.45 4.69 68 16.11 4.15Maximum pool/assets (%) 120 0.50 0.44 68 0.64 0.32Maximum pool/(cash+DIP) (%) 119 6.92 2.63 68 6.51 1.99

41

Table 4: Logit Models of KERP Adoption in Chapter 11 Firms

The table presents the logit estimates from models that relate KERPs to measures of creditor power,employees’ outside options, governance variables and firm characteristics. The initial sample includes allChapter 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 asof December 31, 2008. We also exclude financial firms, utilities, and firms headquartered outside the U.S.The variables are defined in Appendix Table 1. All of the regressions control for Fama-French 12-industryfixed effects. Numbers in parentheses are z-values. ∗∗∗, ∗∗ and ∗ denote significance at the 1%, 5%, and10% levels, respectively.

(1) (2) (3)

Creditors’ committee 2.411∗∗∗ 2.349∗∗∗ 2.300∗∗∗

(3.6) (3.5) (3.3)DIP financing 1.014∗∗∗ 1.125∗∗∗ 1.075∗∗∗

(3.5) (3.7) (3.2)ThickEmplMarkets 1.314∗∗∗ 1.172∗∗

(2.8) (2.3)IndCompGrowth 1.497∗ 1.490∗

(1.9) (1.9)Industry in distress -0.655 -0.518

(-1.6) (-1.2)R&D intensive industry -0.748∗∗ -0.993∗∗∗

(-2.1) (-2.6)Board independence -1.066

(-1.3)Board size 0.147∗∗

(2.4)CEO-chairman -0.016

(-0.1)Ln(Assets) 0.396∗∗∗ 0.321∗∗ 0.238

(3.0) (2.4) (1.5)Industry-adjusted leverage 0.527∗ 0.398 0.430

(1.9) (1.4) (1.5)Industry-adjusted ROA 1.555∗ 1.788∗ 1.759∗

(1.7) (1.8) (1.6)Institutional ownership 1.298∗∗∗ 1.294∗∗ 1.405∗∗

(2.7) (2.6) (2.6)Pre-packaged -0.967∗∗∗ -1.135∗∗∗ -0.967∗∗∗

(-3.1) (-3.4) (-2.7)Delaware 0.263 0.379 0.516∗

(1.1) (1.5) (1.9)Constant -6.088∗∗∗ -5.119∗∗∗ -4.569∗∗∗

(-5.2) (-4.1) (-3.3)

Pseudo R2 0.22 0.24 0.26

Observations 416 414 378

42

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

This table reports results from multinomial logit regressions for the adoption of KERPs. The referencecategory is the set of firms that do not pay either retention or incentive bonuses. The alternative categoriesare firms that pay incentive bonuses (either with retention bonuses or without) and those that pay onlyretention bonuses. 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. All ofthe regressions 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)

Incentive Plans

Creditors’ committee 1.526∗∗ 1.536∗∗

(2.1) (2.0)DIP financing 1.723∗∗∗ 1.709∗∗∗

(4.0) (3.7)ThickEmplMarkets 1.287∗∗ 1.054∗

(2.3) (1.7)IndCompGrowth 2.446∗∗∗ 2.659∗∗∗

(2.6) (2.7)Industry in distress -0.952∗ -0.876

(-1.9) (-1.6)R&D intensive industry -1.187∗∗∗ -1.382∗∗∗

(-2.7) (-2.8)Board independence -2.386∗∗

(-2.5)Board size 0.198∗∗∗

(2.9)CEO-chairman -0.237

(-0.7)Ln(Assets) 0.336∗∗ 0.248

(2.2) (1.4)Industry-adjusted leverage 0.358 0.491

(1.0) (1.4)Industry-adjusted ROA 2.589∗ 2.293

(1.9) (1.5)Institutional ownership 1.656∗∗∗ 2.137∗∗∗

(2.8) (3.3)Pre-packaged -1.428∗∗∗ -1.145∗∗

(-3.3) (-2.5)Delaware 0.387 0.561∗

(1.3) (1.7)Constant -5.173∗∗∗ -4.272∗∗∗

(-3.6) (-2.6)

43

Table 5 Continued

(1) (2)

Retention-Only Plans

Creditors’ committee 16.145 16.144(0.0) (0.0)

DIP financing 0.593 0.544(1.6) (1.4)

ThickEmplMarkets 1.428∗∗ 1.289∗∗

(2.5) (2.0)IndCompGrowth 0.440 0.334

(0.5) (0.3)Industry in distress -0.344 -0.233

(-0.7) (-0.5)R&D intensive industry -0.235 -0.522

(-0.5) (-1.1)Board independence 0.279

(0.3)Board size 0.085

(1.1)CEO-chairman 0.219

(0.6)Ln(Assets) 0.295∗ 0.258

(1.8) (1.3)Industry-adjusted leverage 0.357 0.249

(0.9) (0.6)Industry-adjusted ROA 0.962 1.287

(0.9) (1.0)Institutional ownership 0.714 0.557

(1.1) (0.8)Pre-packaged -0.800∗ -0.723∗

(-2.0) (-1.7)Delaware 0.372 0.464

(1.2) (1.4)Constant -19.502 -19.670

(-0.0) (-0.0)

Pseudo R2 0.23 0.25

Observations 414 378

44

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389

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45

Table 7: CEO Participation in KERPs

The table presents logit estimates from regressions that predict the participation of CEOs in KERPs asa function of CEO characteristics, governance variables, firm and bankruptcy characteristics. The initialsample includes all Chapter 11 filings by U.S.public firms with book assets above $100 million (in constant1980 dollars) from 1996 to 2007. We exclude bankruptcy cases that were dismissed and those that werestill pending as of December 31, 2008. We also exclude financial firms, utilities, and firms headquarteredoutside the U.S. The variables are defined in Appendix Table 1. All regressions control for Fama-French12-industry fixed effects. Numbers in parentheses are z-values. ∗∗∗, ∗∗ and ∗ denote significance at the1%, 5%, and 10% levels, respectively.

CEO Participation in KERPs CEO Participation in Incentive Plans

(1) (2) (3) (4) (5) (6)

CEO age ≥ 60 -0.217 -0.294 -0.227 -0.677 -0.768∗ -0.985∗

(-0.7) (-0.9) (-0.6) (-1.6) (-1.7) (-1.9)CEO tenure 0.025 0.026 0.020 0.007 0.010 0.014

(0.9) (0.9) (0.6) (0.2) (0.3) (0.3)CEO-founder 0.034 0.045 0.310 0.302 0.288 0.846

(0.1) (0.1) (0.7) (0.7) (0.7) (1.6)CEO incumbent -0.161 -0.056

(-0.5) (-0.1)CEO internal hire 0.256 0.252 0.310 0.291

(0.7) (0.6) (0.7) (0.5)CEO external hire -0.218 -0.546 -0.430 -0.930

(-0.6) (-1.2) (-0.9) (-1.5)CEO turnaround specialist 0.905∗∗ 0.720 0.790 0.455

(2.1) (1.4) (1.4) (0.7)Creditors’ committee 2.004∗∗∗ 1.478

(2.9) (1.6)DIP financing 0.756∗∗ 1.606∗∗∗

(2.0) (2.8)ThickEmplMarkets 0.253 -0.374

(0.4) (-0.5)IndCompGrowth 0.377 2.118∗

(0.4) (1.9)Industry in distress 0.095 -0.186

(0.2) (-0.3)R&D intensive industry -0.868∗∗ -0.812

(-2.1) (-1.5)Board independence 0.481 -1.740

(0.5) (-1.5)Board size 0.148∗∗ 0.169∗∗

(2.2) (2.2)CEO-chairman 0.110 -0.326

(0.3) (-0.8)

46

Table 7 Continued

CEO Participation in KERPs CEO Participation in Incentive Plans

(1) (2) (3) (4) (5) (6)

Ln(Assets) 0.124 0.325∗

(0.8) (1.7)Industry-adjusted leverage 0.735∗∗ 1.136∗∗∗

(2.2) (2.8)Industry-adjusted ROA 1.012 1.238

(1.1) (0.7)Institutional ownership 1.649∗∗∗ 2.628∗∗∗

(2.9) (3.7)Pre-packaged -0.691∗ -0.760

(-1.8) (-1.5)Delaware 0.526∗ 0.677∗

(1.8) (1.8)Constant -0.421 -0.545 -5.401∗∗∗ -1.082∗∗ -1.077∗∗ -6.486∗∗∗

(-1.0) (-1.2) (-3.5) (-2.3) (-2.1) (-3.4)

Pseudo R2 0.03 0.02 0.22 0.04 0.06 0.30

Observations 354 354 344 355 355 345

47

Table 8: Effect of KERPs on Chapter 11 Outcomes

The table examines the effect of KERPs on emergence from bankruptcy, duration of bankruptcy, andAPR deviation. Logit regressions are use in Columns (1) to (3), and bivariate probit regressions are usedin Columns (4) to (6). The initial sample includes all Chapter 11 filings by U.S public firms with bookassets above $100 million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcy casesthat were dismissed and those that were still pending as of December 31, 2008. We also exclude financialfirms, utilities, and firms headquartered outside the U.S. The variables are defined in Appendix Table1. All of the regressions control for Fama-French 12-industry fixed effects. Numbers in parentheses arez-values. ∗∗∗, ∗∗ and ∗ denote significance at the 1%, 5%, and 10% levels, respectively.

Emergence Dur> 12M APRDev Emergence Dur> 12M APRDev

(1) (2) (3) (4) (5) (6)

Logit Regressions Bivariate Probit Regressions

KERP 0.515∗ 0.821∗∗∗ -1.147∗∗∗ 1.378∗∗ 0.001 -0.527(1.8) (2.8) (-2.7) (2.0) (0.0) (-0.6)

Creditors’ committee -0.487 1.927∗∗∗ -0.317 -0.634∗ 1.156∗∗∗ -0.202(-1.0) (3.2) (-0.8) (-1.7) (3.3) (-0.7)

DIP financing 0.170 -0.320 -0.178 -0.099 -0.100 -0.137(0.6) (-1.0) (-0.5) (-0.4) (-0.4) (-0.6)

Secured debt/assets 0.721 -0.122 -0.632 0.276 -0.044 -0.324(1.3) (-0.5) (-1.0) (1.0) (-0.3) (-0.9)

Equity committee 0.805∗ 0.678 0.647 0.328 0.440∗ 0.400(1.8) (1.5) (1.4) (1.2) (1.7) (1.5)

Industry in distress 0.199 0.659 -0.277 0.146 0.335 -0.116(0.5) (1.6) (-0.5) (0.6) (1.3) (-0.4)

R&D intensive industry 0.253 -0.020 0.295 0.293 -0.050 0.173(0.7) (-0.1) (0.7) (1.5) (-0.2) (0.7)

Ln(Assets) 0.292∗∗ 0.119 0.332∗ 0.076 0.115 0.167(2.2) (0.8) (1.9) (0.6) (1.1) (1.4)

Industry-adjusted leverage 1.321∗∗∗ -0.438 0.108 0.529∗ -0.185 0.070(3.1) (-1.2) (0.3) (1.8) (-0.8) (0.3)

Industry-adjusted ROA 0.173 0.607 -0.212 -0.265 0.471 -0.029(0.3) (1.0) (-0.2) (-0.6) (1.2) (-0.1)

Institutional ownership 0.280 -0.762 0.912 -0.100 -0.319 0.415(0.5) (-1.4) (1.3) (-0.3) (-0.8) (0.9)

Pre-packaged 2.201∗∗∗ -2.523∗∗∗ 2.122∗∗∗ 1.390∗∗∗ -1.555∗∗∗ 1.205∗∗∗

(5.7) (-7.2) (5.5) (6.1) (-7.7) (4.7)Delaware -0.573∗∗ 0.041 0.268 -0.391∗∗∗ 0.071 0.106

(-2.2) (0.2) (0.8) (-2.7) (0.4) (0.5)Constant -2.653∗∗ -1.600 -4.473∗∗∗ -0.925 -1.085 -2.410∗∗∗

(-2.4) (-1.3) (-3.2) (-0.9) (-1.4) (-2.9)

Pseudo R2 0.25 0.33 0.24Wald χ2 250.32 192.83 159.87Sign of ρ - + -LR test of ρ = 0 (p-value) 0.147 0.531 0.883Observations 410 410 410 408 408 408

48

Table 9: Effect of Incentive Plans on Chapter 11 Outcomes

The table examines the effect of incentive plans on emergence from bankruptcy, duration of bankruptcy,and APR deviation. Logit regressions are used in Columns (1) to (3) and bivariate probit regressions areused in Columns (4) to (6). The initial sample includes all Chapter 11 filings by U.S public firms withbook assets above $100 million (in constant 1980 dollars) from 1996 to 2007. We exclude bankruptcycases that were dismissed and those that were still pending as of December 31, 2008. We also excludefinancial firms, utilities, and firms headquartered outside the U.S. The variables are defined in AppendixTable 1. All of the regressions control for Fama-French 12-industry fixed effects. Numbers in parenthesesare z-values. ∗∗∗, ∗∗ and ∗ denote significance at the 1%, 5%, and 10% levels, respectively.

Emergence Dur> 12M APRDev Emergence Dur> 12M APRDev

(1) (2) (3) (4) (5) (6)

Logit Regressions Bivariate Probit Regressions

Incentive plan 0.315 0.373 -0.778 1.686∗∗∗ -1.495∗∗∗ -1.335∗

(1.0) (1.1) (-1.6) (15.1) (-13.3) (-1.7)Creditors’ committee -0.377 2.111∗∗∗ -0.486 -0.416∗ 1.078∗∗∗ -0.198

(-0.8) (3.5) (-1.3) (-1.7) (4.0) (-0.8)DIP financing 0.206 -0.239 -0.281 -0.179 0.183 -0.021

(0.7) (-0.8) (-0.8) (-1.1) (1.1) (-0.1)Secured debt/assets 0.697 -0.066 -0.561 0.317 -0.049 -0.268

(1.3) (-0.3) (-0.9) (1.4) (-0.4) (-0.8)Equity committee 0.837∗ 0.732 0.618 0.349 0.284 0.337

(1.9) (1.6) (1.3) (1.6) (1.3) (1.3)Industry in distress 0.154 0.592 -0.216 0.163 0.143 -0.159

(0.4) (1.5) (-0.4) (0.8) (0.7) (-0.6)R&D intensive industry 0.244 -0.045 0.262 0.461∗∗ -0.334∗ 0.024

(0.7) (-0.1) (0.6) (2.6) (-1.8) (0.1)Ln(Assets) 0.317∗∗ 0.163 0.304∗ 0.063 0.144∗∗ 0.201∗∗

(2.4) (1.1) (1.8) (0.9) (2.0) (2.1)Industry-adjusted leverage 1.349∗∗∗ -0.404 0.094 0.465∗∗∗ -0.022 0.136

(3.2) (-1.2) (0.3) (2.6) (-0.1) (0.7)Industry-adjusted ROA 0.220 0.684 -0.335 -0.194 0.637∗ 0.121

(0.3) (1.1) (-0.4) (-0.5) (1.7) (0.2)Institutional ownership 0.334 -0.648 0.800 -0.283 0.160 0.570

(0.6) (-1.2) (1.2) (-1.0) (0.6) (1.4)Pre-packaged 2.139∗∗∗ -2.592∗∗∗ 2.201∗∗∗ 1.314∗∗∗ -1.445∗∗∗ 0.958∗∗

(5.6) (-7.3) (5.8) (7.3) (-8.1) (2.4)Delaware -0.529∗∗ 0.114 0.251 -0.335∗∗ 0.110 0.149

(-2.1) (0.4) (0.8) (-2.5) (0.8) (0.9)Constant -2.789∗∗ -1.901 -4.292∗∗∗ -0.926 -1.080∗ -2.375∗∗∗

(-2.5) (-1.6) (-3.1) (-1.6) (-1.8) (-3.2)

Pseudo R2 0.25 0.31 0.23Wald χ2 297.61 307.30 164.31Sign of ρ - + +LR test of ρ = 0 (p-value) 0.000 0.007 0.360Observations 410 410 410 408 408 408

49

Table 10: Plan Objectives and Emergence from Chapter 11

The table presents estimates from the logit regressions that examine the effect of specific plan objectiveson the likelihood of a firm’s emergence from bankruptcy. The initial sample includes all of the Chapter11 filings by U.S. public firms with book assets above $100 million (in constant 1980 dollars) from 1996 to2007. We exclude bankruptcy cases that were dismissed and those that were still pending as of December31, 2008. We also exclude financial firms, utilities, and firms headquartered outside the U.S. The variablesare defined in Appendix Table 1. All of the regressions 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) (5) (6)

Retention plan - minimum stay 0.389 0.811∗∗

(1.3) (2.2)Retention plan - plan confirmation 0.009 -0.549

(0.0) (-1.3)Objective - emerge 1.175∗∗∗ 1.555∗∗∗

(2.7) (2.6)Objective - asset sale -2.451∗∗∗ -3.217∗∗∗

(-3.7) (-4.2)Objective - EBITDA 0.854∗∗ 1.106∗∗

(2.1) (2.1)Creditors’ committee -0.430 -0.366 -0.410 -0.260 -0.390 -0.430

(-0.9) (-0.7) (-0.8) (-0.5) (-0.8) (-0.8)DIP financing 0.101 0.166 0.152 0.352 0.192 -0.022

(0.3) (0.5) (0.5) (1.2) (0.6) (-0.1)Secured debt/assets 1.174∗ 1.119∗ 0.689 0.702 0.707 1.347∗∗

(1.9) (1.8) (1.3) (1.3) (1.3) (2.0)Equity committee 0.825∗ 0.826∗ 0.947∗∗ 0.664 0.793∗ 0.754

(1.8) (1.8) (2.1) (1.5) (1.8) (1.5)Industry in distress 0.290 0.252 0.194 0.136 0.169 0.513

(0.7) (0.7) (0.5) (0.4) (0.4) (1.2)R&D intensive industry 0.265 0.238 0.167 0.099 0.258 0.218

(0.8) (0.7) (0.5) (0.3) (0.8) (0.6)Ln(Assets) 0.277∗∗ 0.320∗∗ 0.298∗∗ 0.316∗∗ 0.320∗∗ 0.169

(2.0) (2.3) (2.2) (2.3) (2.4) (1.1)Industry-adjusted leverage 1.712∗∗∗ 1.747∗∗∗ 1.338∗∗∗ 1.379∗∗∗ 1.352∗∗∗ 1.743∗∗∗

(3.7) (3.7) (3.1) (3.2) (3.2) (3.5)Industry-adjusted ROA 0.459 0.475 0.226 0.299 0.221 0.534

(0.7) (0.7) (0.3) (0.5) (0.3) (0.8)Institutional ownership 0.424 0.466 0.130 0.855 0.331 0.669

(0.8) (0.9) (0.2) (1.5) (0.6) (1.1)Pre-packaged 2.058∗∗∗ 1.988∗∗∗ 2.152∗∗∗ 1.983∗∗∗ 2.131∗∗∗ 2.086∗∗∗

(5.3) (5.1) (5.7) (5.2) (5.6) (5.2)Delaware -0.478∗ -0.461∗ -0.523∗∗ -0.494∗ -0.534∗∗ -0.495∗

(-1.8) (-1.7) (-2.0) (-1.9) (-2.1) (-1.7)Constant -2.782∗∗ -2.975∗∗ -2.516∗∗ -2.783∗∗ -2.818∗∗ -2.113∗

(-2.4) (-2.6) (-2.2) (-2.4) (-2.5) (-1.7)

Pseudo R2 0.26 0.26 0.26 0.28 0.25 0.34

Observations 391 391 410 410 410 391

50

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 ratioIndustry-adjusted leverage Firm leverage minus the (same-2-digit SIC) industry median leverageROA Ratio of EBITDA to book assetsIndustry-adjusted ROA Firm ROA minus the (same-2-digit SIC) industry median ROASecured debt/assets Ratio of secured debt to book assetsInstitutional ownership Institutional ownership (in %)Industry in distress 0/1 dummy varaible, equals 1 if the median stock return of same 2-digit

SIC industry is -30% or less in the year before a firm files for bankruptcyR&D intensive industry 0/1 dummy variable, equals 1 if the median R&D/assets of the same 2-digit

SIC industry is above 1%ThickEmplMarkets 0/1 dummy variable, equals 1 if there are 20 or more firms

in the same-2-digit SIC 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, equals 1 if bankruptcy is pre-packaged or prenegotiatedDelaware 0/1 dummy variable, equals 1 if bankruptcy filed in DelawareDIP financing 0/1 dummy variable, equals 1 if debtor obtained DIP financingCreditors’ committee 0/1 dummy variable, equals 1 if creditor committee appointedEquity committee 0/1 dummy variable, equals 1 if equity committee appointedReorganization 0/1 dummy variable, equals 1 if firm reorganized in Chapter 11Liquidation 0/1 dummy variable, equals 1 if firm is liquidatedAcquisition 0/1 dummy variable, equals 1 if firm is acquiredDuration Months in bankruptcy from filing to plan confirmationAPRDev 0/1 dummy variable, equals 1 if equity holder receive payoffs

before creditors are paid in full.

Governance and CEO Characteristics

Board independence Proportion of independent directors on the boardBoard size Number of directors on the boardCEO-chairman 0/1 dummy variable, equals 1 if CEO is also chairman of the boardCEO-founder 0/1 dummy variable, equals 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, equals 1 if CEO is with the firm three years before filingCEO internal hire 0/1 dummy variable, equals 1 if the newly-hired CEO is hired internallyCEO external hire 0/1 dummy variable, equals 1 if the newly-hired CEO is hired externallyCEO turnaround specialist 0/1 dummy variable, equals 1 if the external hire is a turnaround specialist

51

Appendix Table 1 continued

Variable Definition

Key Employee Retention Plans

KERP 0/1 dummy variable, equals 1 if retention/incentive plan approvedRetention 0/1 dummy variable, equals 1 if firm offers retention bonusesIncentive 0/1 dummy variable, equals 1 if firm offers incentive bonusesKey employees # key employees in planKey employees/total employees # of key employees/# of total employeesTier groups Number of tier groupsEmployees: highest tier group # of employees in the highest tier groupEmployees: lowest tier group # of employees in the lowest tier groupRetention bonus-highest tier Bonus (as % of salary) in the highest tier groupRetention bonus-lowest tier Bonus (as % of salary) in the 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, equals 1 if retention bonus tied to minimum stayRetention: plan confirmation 0/1 dummy variable, equals 1 if retention bonus tied to plan confirmation.

Objectives in Incentive Plans

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

52

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 installments 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.

53

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

55

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%of the participants’ base pay payable at various critical points in the Debtor’s Chapter 11case. 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 of 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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