Financial Distress, Liquidation, and Corporate Restructuring
Financial Distress, Reorganization, and Liquidation
Paid for Target Companies
This week, we will discuss financial distress, bankruptcy, and liquidation (chapter 22), as well as mergers and
acquisitions. It is important to note the various bankruptcy methods and the priority of claims in the liquidation
process. In M & As, the success of the combination is usually determined after several years of coexistence of the
combination, when the impact of possible synergies can be assessed.
There is a dark side of debt; namely, financial distress and
bankruptcy, if interest and principal payments are not made in a
timely manner (when due). We learned in the course of Managerial
Finance and in Week 1 (when we discussed an optimal capital
structure) that, for corporations, the payment of interest is a
deductible expense when calculating taxable income. The tax
subsidy reduces (lowers) the cost of debt. Because debt costs less
than equity (preferred and common stock), firms use more of it.
When a firm uses too much debt and cannot make interest and
principal payments as required, bankruptcy often results.
Although bankruptcy law is federal, it does have state implications. The two chapters of the bankruptcy code that
concern us are chapter 7, "Liquidation," and chapter 11, "Reorganization." Although both chapters are important
in the world of finance, we are more concerned with chapter 7, as it provides us opportunities to see how the
priority of claims works and how debt subordination works. Also of interest is the cram down concept, sometimes