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Associated with financial distress is a cost that would not have been imposed in the absence of debt. Management options under financial distress: Restructure liabilities: negotiate and restructure debt claims, raise new capital Restructure assets: asset sales, layoffs (ontslagen) Declare bankruptcy: - Liquidation: court appoints trustee to liquidate assets (de rechter kiest een curator), cash will be distributed following a strict schedule (secured claims, wages, taxes, unsecured claims, equity). - Reorganization: debtor, debtor-in-possession, proposes reorganization plan in court Example: In a perfect capital market, there are no cost of financial distress (transfer of ownership from equityholders to debtholders, no reduction in cash flows generated by the firm). Verspreiden niet toegestaan | Gedownload door allard molenaar ([email protected])lOMoARcPSD
9 Cost of financial distress (legal expenses, court costs, advisory fees etc.): Interest and principal payments to debtholders are legal obligations (wettelijke verplichtingen). Dividends are common but voluntary (vrijwillig) Only failed payments to debtholders have negative legal consequences related with costs. Economists broadly agree that direct cost of financial distress are too small to account for the low debt ratios we see in reality. But there are other, indirect costs of financial distress (loss of customers, suppliers, employees, receivables, fire sales of assets, delayed liquidation) that could potentially be much more important. It is very difficult to quantify indirect costs of financial distress. We need to estimate losses to total value and we need to estimate incremental losses of financial distress are independent of economic distress. Many indirect costs are incurred prior and irrespective of whether actual bankruptcy occurs. Therefore, the economic magnitude may be more important. Hoorcollege 4 –5 november 2014 Managers dislike leverage: larger fraction of free cash flows reserved for interest payments and thereby not under manager’s control, managers are most likely fired in states of financial distress. Agency conflicts: costly disagreements among stakeholders in a firm. Conflicts between managers, shareholders and debtholders. 1.Managers maximize shareholder value: managers and shareholder interests are aligned, conflict between shareholder and debtholder. 2.Managers follow own objectives: conflict between manager and shareholder, potential conflict between manager and debtholder. Agency conflicts between managers and investors Agency costs of debt Wealth Transfers: by issuing additional debt of equal seniority, a firm makes existing debtholders’ claims more risky to the benefit of shareholders. Debtholders, a senior claimants to a firm’s cash flows, are worried about dilutions to their detriment (nadeel).
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Corporate Finance, Verspreiden niet toegestaan, door allard molenaar, Gedownload door allard, Gedownload