This definition has two general themes stocks and flows 3 These two ways of

This definition has two general themes stocks and

  • University Canada West
  • UCW 002
  • Notes
  • sarahadams1409
  • 16
  • 83% (6) 5 out of 6 people found this document helpful

This preview shows page 2 - 5 out of 16 pages.

This definition has two general themes: stocks and flows. 3 These two ways of thinking about insolvency are depicted in Figure 30.1 . Stock-based insolvency occurs when a firm has negative net worth, so the value of assets is less than the value of its debts. Flow-based insolvency occurs when operating cash flow is insufficient to meet current obligations. Flow-based insolvency refers to the inability to pay one’s debts. Insolvency may lead to bankruptcy. Some of the largest U.S. bankruptcies are in Table 30.1 . Figure 30.1 Insolvency
Image of page 2
30.2 What Happens in Financial Distress? In June 2008, General Motors (GM) reported second quarter net income of negative $15 million. It also lost money in 2005 and 2007 and steadily lost its market share to rivals such as Toyota, BMW, and Honda. Its accounting shareholder equity turned negative in 2006 and its stock price decreased from $50 in late 2003 to about $1 in 2009. Automobile customers had good reason to worry about buying cars from GM. GM struggled to increase sales, cut costs, attempted to sell assets (e.g., the Hummer line), drew down bank debt, and arranged for more long-term financing. GM was clearly a firm experiencing financial distress. GM filed for bankruptcy on June 1, 2009. Firms deal with financial distress in several ways, such as these: 1. Selling major assets. 2. Merging with another firm. 3. Reducing capital spending and research and development. 4. Issuing new securities. 5. Negotiating with banks and other creditors. 6. Exchanging debt for equity. 7. Filing for bankruptcy. Items (1), (2), and (3) concern the firm’s assets. Items (4), (5), (6), and (7) involve the right side of
Image of page 3
the firm’s balance sheet and are examples of financial restructuring. Financial distress may involve both asset restructuring and financial restructuring (i.e., changes on both sides of the balance sheet). Some firms may actually benefit from financial distress by restructuring their assets. For example, a levered recapitalization can change a firm’s behavior and force a firm to dispose of unrelated businesses. A firm going through a levered recapitalization will add a great deal of debt and, as a consequence, its cash flow may not be sufficient to cover required payments, and it may be forced to sell its noncore businesses. For some firms, financial distress may bring about new organizational forms and new operating strategies. However, in this chapter we focus on financial restructuring. Financial restructuring may occur in a private workout or a bankruptcy reorganization under Chapter 11 of the U.S. bankruptcy code. Figure 30.2 shows how large public firms move through financial distress. Approximately half of the financial restructurings have been done via private workouts. Most large public firms (approximately 83 percent) that file for Chapter 11 bankruptcy are able to reorganize and continue to do business.
Image of page 4
Image of page 5

You've reached the end of your free preview.

Want to read all 16 pages?

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture

  • Left Quote Icon

    Student Picture