1. Kaist Informaiton&Media MBA 20093988 Hahm, Seung-wan 20093837 Yeo ju 20093998 Hwang, do-won
The costs of conflict resolution and financial distress: Evidence from the Texaco-Pennzoil litigation

2. Table of Contents Introduction 2. The conflict
3. The effects of the conflict on shareholder wealth
4. The effects on other claimants
5. Where did the value go?
6. Conclusions and implications

4. I. Introduction

5. Reducing the combined equity value
1. Introduction
Case : The litigation between Texaco and Pennzoil over the Getty oil
takeover (1984~1988)
Large fluctuation in value
During the litigation
Reducing the combined equity value
Asymmetric returns
Texaco’s
shareholders
Pennzoil’s
owners
Texaco
value
leakages
$ 1 Lose
$3.4 billion
(over 30 %)
$ 0.4Gain
Pennzoil
value
Joint
value
Before dispute
ongoing dispute

6. II. History of conflict

7. Texas state supreme court Federal court of appeals
2. History of conflict
U.S court structure
[ Texas State ]
[ Federal]
Texas state supreme court
Texas court of appeals
Texas state court
supreme court
Federal court of appeals
Federal court
History of conflict
Date
Court
Event
Additional information
1985,
11/19
Texas state court
In favor of Pennzoil
Total $12.03 billions(B)
- result : jury are decried
$7.53B in actual damage
$3B in punitive damage
$1.5B in accrued interest
12/10
Texas jury denied Texaco’s request to overrule the jury
Award($12.03B) is affirmed

8. 2. History of conflict (cont)
Date
Court
Event
Additional information
1985,
12/18
Federal
Texaco received a temporary Restraining order
It’s temporary until bond matter could be decided
1986,
1/10
court
Texaco bond requirement
is reduced
Only $ 1 billion bond
2/20
Federal court of appeals
Uphold bond reduction
original case and bond case
were appealed
1987,
2/12
Texas court of appeals
Uphold $2 billion of the judgment for Pennzoil
<= original case’s award
4/6
Supreme
Vacated the federal court ruling
<= bond case
4/12 -
Texaco filed for bankruptcy
After bankruptcy, Texaco appealed the case to upper court
11/2
Texas state supreme court
Declined to review the case
1987 , 12/11
$3 billion settlement in Texaco’s shareholders’ committee (& Carl Icahn)
Trial court : 사실심 법정

9. III. The Effects of the Conflict on Shareholder Wealth

10. 3. The Effects of the Conflict on Shareholder Wealth
Measures market value of both companies.
Examines the correlation between the stocks’ abnormal value.
F-1. Litigation News and Change in Value
F-2. Settlement News and Change in Value
(million)
(million)
- Frequent news: lower correlation.
Litigation costs: change in value of the two companies.
Penzoil’s gain = 6X Texaco’s loss
- After settlement, the value was recovered.

11. 3. The Effects of the Conflict on Shareholder Wealth
Nov 1985 → Oct = $3.7B↓
After settlement: combined value = $2.6B↑
Change Value
=-$1.1B
Shareholders Cost
Billions Of Dollars
Time
1986
1987 6 4 8
1) $3.7B
2) $2.6B
Figure-3. Combined Value of Texaco & Pennzoil

12. IV. The Effect on Other Claimants -Texaco’s Bondholders

13. 4. The Effect on Other Claimants
1) Texaco’s Bondholders
Reorganization : Claims can be reduced or eliminated entirely.
Liquidation(청산) : Redemption of outstanding debt at par value, not market value.
T-1. Change in Value of Texaco Debt
The return to bondholders mirrored that to stockholders.
Dramatic increase in value → due to the resolution of the dispute.
After settlement, debt value increased.
Total value -$986B

14. 4.The Effect on Other Claimants
2) The Government
-Federal law of Damage Payment Taxable or Deductible
F-3. Tax flow
Damage Payment
Tax Deduction
Tax Liability

15. 4.The Effect on Other Claimants – The Government
3 considerations suggest that the litigation could have tax consequences,
however..
3 considerations
1. The Texaco couldn’t use all of tax losses generated by a payment to Pennzoil.
2. Distinction between “ordinary income” and “capital gains” lowered tax liability
of Pennzoil.
3. Capital gain is not liable in case of “Involuntary Conversion” within 2 years.
Claims of these creditors do not counter the loss or increase in value.
The effects on no equity claims cannot explain the equity losses and
the fluctuations in value did not reflect transfers among claimants.

16. V. Where did the value go?

17. Free cash flow may be invested at below the market return
5. Where did the value go?
1) Legal payment
2) Fail to manage fund
Settlement
Total legal payment
Pennzoil would not use any funds it received from Texaco so efficiently
14% of the resulting increase in value to Pennzoil
Free cash flow may be invested at below the market return
Texaco
Pennzoil
$250M
$400M
After tax joint total
$ 525M
15% loss of Joint value
Lowering the value of the pennzoil

18. The large fluctuations
5. Where did the value go?
3) Secondary Costs
4) Responsibility of take over
Suppliers
The large fluctuations
Favorable litigation announcement
Negative litigation announcement
Make operating hard
Value up
Value down
Bank
Stock market
After initiate litigation decisions the possibility decreased 1
Make financing hard
Give negative view
Carl Icahn tried to acquire the companies in hostile takeovers 2
Texaco’s credit & financial condition had been declined 3
After settlement

19. 5) Inefficient valuation
5. Where did the value go?
5) Inefficient valuation
The market in efficiently valued the claims of two company 1
The hypothesis of market error in valuing two companies is attractive - But there must be strong general grounds for doubting the rationality of market valuation 2

20. VI. Conclusion 5. Where did the value go? 5) Inefficient valuation
The market inefficiently valued the claims of two companies
The hypothesis of market error in valuing two companies is attractive
In this case, - matters of public records are involved.
- they were widely followed and actively traded throughout the period.
- the valuation pattern persisted over two years, and was noted on several occasions in the financial press.
VI. Conclusion

21. 6. Conclusions Total cost Different Expectations
Market expect that it will be $2billion
Direct Expenses
Indirect Expenses
Legal fee - $525million
Interfered with firm’s abilities to obtain working capital and make them less profitable- not measurable but greater than direct expenses

22. Total joint loss -$1.1billion
6. Conclusions
History about total loss
Litigation
Settlement
$3.7 billion
$2.6 billion
$10.5 billion
$9.4 billion
Total joint loss -$1.1billion
The best way to avoid the litigation
A bargain should be stuck immediately
A bargain costs should not be incurred
There would not be third party
Value
Both parties must be fully informed

23. Thank you ! 5. Where did the value go? 5) Inefficient valuation
The market inefficiently valued the claims of two companies
The hypothesis of market error in valuing two companies is attractive
In this case, - matters of public records are involved.
- they were widely followed and actively traded throughout the period.
- the valuation pattern persisted over two years, and was noted on several occasions in the financial press.
Thank you !