Mergers or State Aid: Firms in Difficulty Trade-off to Avoid Bankruptcy

• Date: 01 March 2020
• Author: Juliette Rey
• DOI: 10.1177/0003603X19898907
• Published date: 01 March 2020
• Subject Matter: Articles

Article

Mergers or State Aid: Firms

in Difficulty Trade-off

to Avoid Bankruptcy

Juliette Rey*

Abstract

This article analyzes one aspect of the trade-off between state aid and mergers faced by ailing firms

when they want to avoid bankruptcy. It questions the existence of strategic aid made with the unique

goal of influencing the competition authority’s beliefs regarding the competition. To analyze those aids,

we create a model in which an authority is trying to deter strategic aid while being uninformed about

competition. We show that when firms in difficulty know about the authority’s beliefs regarding

competition, they implement strategic aid. The authority is able to deter them, but has to choose

between deterring them and maximizing firms’ survival. When firms do not know the authority’s

beliefs, strategic aid exists, and the authority is not able to minimize the percentage of aid. Never-

theless, the authority is efficient since simulations show that less than 1% of firms in difficulty are

implementing strategic aid, thanks to this policy.

Keywords

state aid, public aid, mergers, firms in difficulty

I. Introduction

Firms may face difficulties for many reasons: liquidity issues, decline of activity, managerial issues,

and high costs, among others. In those cases, they risk bankruptcy. Since bankruptcy is quite costly

(administrative and legal costs are discussed by Martin J. Gruber & Jerold B. Warner,

1

Kent Clark &

Eli Ofek,

2

Victor Pastena & William Ruland,

3

and Ronald E. Shrieves & Donald L. Stevens

4

), firms in

*Associate Professor, Erudite/University Paris Est Cr´

eteil, Cr´

eteil, Paris, France

Corresponding Author:

Juliette Rey, Associate Professor, Erudite/University Paris Est Cr´

eteil, 61 Avenue du G´

en´

eral de Gaulle, Cr´

eteil 94010, Paris,

France.

Email: juliette.m.rey@gmail.com

1. Martin J. Gruber & Jerold B. Warner, Bankruptcy Costs: Some Evidence,32J.FIN. 337–47 (1977).

2. Kent Clark & Eli Ofek, Mergers as a Means of Restructuring Distressed Firms: An Empirical Investigation,29J.F

IN.&

QUANT.ANALYSIS 541–65 (1994).

3. Victor Pastena & William Ruland, The Merger/Bankruptcy Alternative,61A

CCT.REV. 288–301 (1986).

4. Ronald E. Shrieves & Donald L. Stevens, Bankruptcy Avoidance as a Motive for Merger,14J.F

IN.&QUANT.ANALYSIS 501–

515 (1979).

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2020, Vol. 65(1) 148-163

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DOI: 10.1177/0003603X19898907

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difficulty may try to avoid bankruptcy. One interesting question concerns the actions that they take in

order to do so and to continue their activities.

In Europe, firms in difficulty can ask for a form of aid that is referred to as “rescuing and

restructuring state aid.” This is a particular form of public aid that is addressed to firms in difficulty

to help them survive and restructure. It is strictly controlled by the European Commission through

articles 107 to 109 of the Treaty on the Functioning of the European Union.

5

Those articles forbid state

aid per se and allow exceptions in particular cases (when there is a market failure or when the aid is

given for social and/or regional cohesion reasons). Indeed, state aid in general, and rescuing and

restructuring aid in particular, is seen as very distorting.

6

They may induce a crowding-out effect

(competitors decreasing their investment due to the unfair competition), an exit of the most efficient

firms, or a race between the Member States to allow more aid. Moreover, they have an effective cost

(since they are not always reimbursed) and an opportunity cost, as the money spent on state aid is not

used for other purposes, like decreasing taxes (David R. Collie

7,8

). For those reasons, restructuring

state aid can only be authorized when the negative impact on competition is limited, and even in those

cases, they should be followed by compensatory measures to limit this negative impact. In practice,

compensatory measures are important and often take the form of a restriction in the recipient’s

production. One example is the aid given to Air Malta.

9

Despite the crucial role of this firm in the

supplying of the island, the firm had to give up certain planes, time slots, and destinations in order to

receive the aid.

10

Due to this strict regulation, firms may search for alternatives to state aid in order to restructure and

avoid bankruptcy, and one solution is to merge. Mergers offer a wide range of advantages. They cancel

the legal costs and adverse effects linked to bankruptcy (loss of costumers, difficulties in finding loans,

loss of qualified workers, etc.), as shown by Martin J. Gruber & Jerold B. Warner,

11

Kent Clark & Eli

Ofek,

12

and Victor Pastena & William Ruland.

13

Most of the time, an increase in asset prices can also

be observed (Victor Pastena & William Ruland,

14

Edith Hotchkiss & Robert Mooradian,

15

Amy Kam,

David Citron, & Gulnur Muradoglu

16

),andtheyleadtotaxescarry-forwards.Creditorshavean

incentive to merge in order to recover a part of their funds (Victor Pastena & William Ruland

17

), and

mergers facilitate debt concessions for firms in difficulty. In comparison to rescuing and restructuring

state aid, it is significantly easier for firms to receive an allowance from the European Commission

regarding their mergers. The main regulations on mergers are articles 101, 102, and 106 of the Treaty

on the Functioning of the European Union,

18

the European Commission Merger Regulation, and the

5. Consolidated Version of the Treaty on the Functioning of the European Union, art. 107 to 109, 2012 O.J. (C 326).

6. “Rescue and restructuring aid are among the most distortive types of State aid.”, Eur. Comm’n, Guidelines on State aid for

rescuing and restructuring non-financial undertakings in difficulty, 2014 OJ (C 249).

7. David R. Collie, State aid in the European Union: The Prohibition of Subsidies in an Integrated Market,18I

NT.J.INDUS.

ORG. 867–84 (2000).

8. David R. Collie, Prohibiting State Aid in an Integrated Market: Cournot and Bertrand Oligopolies with Differentiated

Products,2J.I

NDUSTRY COMPETITION &TRADE 215–31 (2002).

9. State aid No SA.33015 (2012/C) which Malta is planning to implement for Air Malta plc., 2012 O.J. (L 301).

10. Id.{116.

11. Gruber & Warner, supra note 1.

12. Clark & Ofek, supra note 2.

13. Pastena & Ruland, supra note 3.

14. Id.

15. Edith Hotchkiss & Robert Mooradian, Acqui sitions as A Means of Restructuring Firms in Chapter 11,7J.F

IN.

INTERMEDIATION 240–62 (1998).

16. Amy Kam, David Citron & Gulnur Muradoglu, Distress and Restructuring in China: Does Ownership Matter?,19C

HINA

ECON.REV. 567–79(2008).

17. Pastena & Ruland, supra note 3.

18. Consolidated Version of the Treaty on the Functioning of the European Union, art. 101, 102 and 106, 2012 O.J. (C 326).

Rey 149