Anatomy of Financial Distress: An Examination of Junk-Bond Issuers

Abstract

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.. Oxford University Press is collaborating with JSTOR to digitize, preserve and extend access to The Quarterly This paper analyzes the ways in which financially distressed firms try to avoid bankruptcy through public and private debt restructurings, asset sales, mergers, and capital expenditure reductions. Our main finding is that a firm's debt structure affects the way financially distressed firms restructure. The combination of secured private debt and numerous public debt issues seems to impede out-of-court restructurings and increases the probability of a Chapter 11 filing. In addition, we find that, while asset sales are a way of avoiding Chapter 11, they are limited by industry factors: firms in distressed and highly leveraged industries are less prone to sell assets.VVhen companies are in financial distress, they try to avoid bankruptcy by restructuring their assets and liabilities. Asset sales, mergers, capital expenditure reductions, and layoffs (on the asset side), and restructurings of bank debt and public debt (on the liability side) are all common responses to distress. Absent a quick turnaround in a company's business, a failure to restructure typically results in a Chapter 11 bankruptcy filing.During the past several years there have been a number of studies that analyze these responses to financial distress. Notable contributions include Gilson [1990] on restructurings of bank claims; Gilson, John, and Lang [1990] on debt restructurings versus bankruptcy; Brown, James, and Mooradian [1993] on public debt restructurings versus bank debt restructurings; Brown, James, and Mooradian [1994] on asset sales; and Franks and Torous [1989] and Hotchkiss [1994] on the Chapter 11 process. This paper tries to put these elements together in a more comprehensive study of how firms respond to financial distress. This content downloaded from 91.229.248.162 on Tue, 10 Jun 2014 06:55:05 AM All use subject to JSTOR Terms and Conditions 626 QUARTERLY JOURNAL OF ECONOMICSThis approach also allows us to look at interactions among different kinds of restructurings. Our study is based on a sample of 102 companies that issued high-yield "junk" bonds during the 1970s and 1980s and subsequently got into financial trouble. Of these 102 companies, 76 took visible steps to restructure their companies in response to distress. We have several principal findings. 1. Bank debt restructurings. Banks respond to financial distress in a number of ways. They "loosen" financial constraints on firms by deferring principal and interest, providing new financing, and waiving covenants; they "tighten" financial constraints by accelerating principal and interest payments, reducing lines of credit, and increasin...

Financial Distress and Bank Restructuring of Small to Medium Size UK Companies*

“…Well-known American studies such as Gilson et al (1990), Asquith et al (1994), LoPucki (1983 and Franks and Torous (1994) use samples of large listed companies with multiple large lenders as well as public bondholders. 8 Compared with these studies, we find a greater concentration of liquidation rights, a virtual absence of court interference, little potential for coordination failures, and far less evidence of debt forgiveness.…”

Financial distress, bank debt restructurings, and layoffs

“…In this respect, let us first say that our results are broadly consistent with the available evidence. Asquith et al (1994), DeAngelo and DeAngelo (1991), John et al (1992), Ofek (1993), Opler and Titman (1994), and Sharpe (1994) show that firms in financial distress downsize their workforces. Gilson (1990), Brown et al (1994), Wruck (1990) and many others find evidence that creditors play a crucial role in the economic restructuring process which takes place during financial reorganization.…”

“…Asquith et al (1994) find that for a sample of 102 U.S. companies which issued high yield debt and then fell in financial distress, banks almost never forgave principal on outstanding loans, so that most restructurings just involved extensions of maturity.19 Although we do not attempt to justify this assumption formally, let us simply note that it seems a natural assignment of bargaining powers given our previous assumptions. Also note that our results below would remain qualitatively unchanged under different bargaining assumptions: all that is required is that the bank's bargaining power be non-negligible.…”

Coverage of financing deficit in firms in financial distress under the pecking order theory

“…However, many fi rms cannot quickly adjust their debt in response to changes in their target debt because they bear transaction costs. Firms in fi nancial distress have a lot of trouble reaching their optimal capital structure proposed by the trade-off theory because they have high transaction costs (Asquith, Gertner, & Scharfstein, 1994;Chou, Li, & Yin, 2010). To reduce their debts, fi rms in fi nancial distress must negotiate new payment terms with creditors or sell assets that implies complicated adjustments.…”