publiclytradedfirmsintheUnitedStatesbetween 1980 and
1983 and foundthat 1,346firms had trouble making their
interestexpensesfromoperatingincomeinatleastoneyear
andthat 151 firmscouldbeconsidereddistressed,inthesense
that they were renegotiating with lenders to restructure debt.
1 Followinguponthesefirms,hefindsthatwhilelessthana
halfof thesefirmsenter Chapter11, only athirdof these
firmssurviveasindependentcompaniesandthattherestare
either acquired or liquidated.
Consequences of Distress
Whataretheconsequencesoffinancialfailure?Firmsthatare
unableto maketheirdebtpayments havetoliquidate their
assets,oftenatbargainbasementprices,andusethecashto
payoffdebt.Ifthereisanycashleftover,whichishighly
unlikely,itwillbepaidouttoequityinvestors.Firmsthatare
unabletomaketheiroperatingpaymentsalsohavetooffer
themselves to thehighestbidder,and theproceedswillbe
distributedto theequityinvestors.Ineffect, theliquidation
costs can be considered the direct costs of bankruptcy.
In fact, the costs of distress stretch far beyond the
conventional costs of bankruptcy and liquidation. The
perception of distress can do serious damage to a firm’s
operations,as employees,customers,suppliers, and lenders
react.Firmsthatareviewedasdistressedlosecustomers(and
sales), havehigher employeeturnover,and have to accept
muchtighterrestrictionsfromsuppliersthanhealthyfirmsdo.
Theseindirectbankruptcycostscanbecatastrophicformany
firmsand essentiallymaketheperceptionofdistressintoa
reality.Themagnitudeofthesecostshasbeenexaminedin
studies and can range from 10 to 25 percent of firm value.