How Costly is Financial (Not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed

Abstract

This paper studies thirty-one highly leveraged transactions~HLTs! that become financially, not economically, distressed. The net effect of the HLT and financial distress~from pretransaction to distress resolution, market-or industry-adjusted! is to increase value slightly. This finding strongly suggests that, overall, the HLTs of the late 1980s created value. We present quantitative and qualitative estimates of the~direct and indirect! costs of financial distress and their determinants. We estimate financial distress costs to be 10 to 20 percent of firm value. For a subset of firms that do not experience an adverse economic shock, financial distress costs are negligible.

Women on Boards and Financial Performance: Evidence from a European Emerging Market

“…According to the theory and empirical evidence [47], both positive and negative effects of leverage could be expected. On the one hand, leverage indicates financial distress, which could be costly either in terms of direct expenses (e.g., legal and financial advisory fees) but mostly in terms of indirect costs such as suboptimal investments or unprofitable assets sales and the management's distraction from the core business activities [48][49][50]. One the other hand, debt could also have a disciplinary role, the scarcity of financial resources orienting firms towards efficiency [51][52][53].…”

Cost of Debt and Corporate Profitability

“…First, a corporate crisis can be affected by firm leverage. More specifically, a high degree of leverage might increase the risk of insolvency and consequently the cost of debt (Altman, 1984;Andrade & Kaplan, 1998;Van Horne & Wachowicz, 2005). Second, a drop in corporate profitability and/or a decline in other variables used as proxies of economic performances are generally interpreted as a sign of economic distress (John, Lang, & Netter, 1992;Kang & Shivdasani, 1997;Andrade & Kaplan, 1998;Jiang & Wang, 2009) and a possible cause of a corporate crisis.…”

“…Indirect costs concern the loss of a substantial market share (Opler & Titman, 1994), changes in operating performances, loss of suppliers, customers and managerial opportunities, a reduction in the ability of firms to obtain credit or issue securities (Altman, 1984), changes in trade receivables and debt policy (Molina & Preve, 2009;George & Hwang, 2010), decreasing investment opportunities (Chen & Merville, 1999) and the lowering of other variables used as proxies of firm profitability (Tan, 2012). These undesirable effects contribute to an increase in the cost of debt and consequently may reduce firm's value (Andrade & Kaplan, 1998;Weiss, 1990;Bris, Welh, & Zhu, 2006). Although several studies have produced estimates of distress cost (Andrade & Kaplan, 1998;Almeida & Philippon, 2007;Van Binsbergen, Graham, & Yang, 2010), its quantification continues to be www.ccsenet.org/ibr International Business Research Vol.…”

“…These undesirable effects contribute to an increase in the cost of debt and consequently may reduce firm's value (Andrade & Kaplan, 1998;Weiss, 1990;Bris, Welh, & Zhu, 2006). Although several studies have produced estimates of distress cost (Andrade & Kaplan, 1998;Almeida & Philippon, 2007;Van Binsbergen, Graham, & Yang, 2010), its quantification continues to be www.ccsenet.org/ibr International Business Research Vol. 7, No.…”

A kapitalizmus új királyai: kockázati tőke Magyarországon és a közép-kelet-európai régióban

“…Emiatt a kockázati tőkések cégei már szakágaza-tuk visszaesése kezdetén gyorsabban válaszlépésekre kényszerülhetnek, ami számukra a recesszió könnyebb átvészelését teheti lehetővé. Ezt az érvelést támasztja alá Andrade-Kaplan [1998] az 1980-as években bajba jutott közel 30 kivásárlási ügyletre vonatkozó elemzése is, amely szerint ezen cégek értéke a kivásárlás előttihez képest kissé javult, azaz még a válságban legsúlyosabban érintett, hitellel kivásárolt cégeknél is keletkezett némi hozzáadott érték.…”