Introduction to Corporate Finance

ONLINE CHAPTER

associated with financial distress may reduce the optimal debt ratio. Clearly, a close link exists between

the costs of insolvency and a company’s capital structure decisions.

Insolvency is only one of many avenues a company may employ to address its problems. When a

company experiences financial distress, it may try to solve that problem through changes in operations

(such as reducing expenditures, selling assets or even merging with a healthy company) or through

financial actions (such as raising new capital by selling new securities, exchanging debt securities for

equity, reducing payout or renegotiating with creditors). The company may go into voluntary administration,

a formal standstill-type administration where the voluntary administrator investigates and reports on

the company’s history and financial position to creditors and makes a recommendation about its future.

Creditors then decide whether to accept a deed of company arrangement, if one is proposed by the

directors; liquidate the company; or return the company to the control of the directors. A deed of company

arrangement is a procedure that permits a company to make a compromise or arrangement that is binding

on all creditors. Subject to the terms of the arrangement, the company may then be saved and continue

to operate. Declaring insolvency is typically a last resort.

Despite the publicity that cases receive, business insolvencies in general do not typically involve many

of the larger companies in the economy – although a number of high-profile, large-scale insolvencies such

as those of Ansett Airlines, HIH Insurance and One.Tel have occurred. A great deal of publicity has been

given to large bankruptcies in the US. Table 22.1 lists the all-time largest US bankruptcies through 2015.

voluntary administration
Occurs when a company
allows an administrator to
investigate and report on
the company to creditors
and make a recommendation
about the future of the
company

deed of company

arrangement

A procedure that permits a

company in distress to make

a compromise or arrangement

that is binding on all creditors.

Subject to the terms of the

arrangement, the company

may then be saved and

continue to operate

TABLE 22.1 LARGEST US BANKRUPTCIES AS AT 2015

Company Bankruptcy date Total assets pre-bankruptcy (in millions)

Lehman Brothers Holdings, Inc. 15/9/2008 $691,063

Washington Mutual, Inc. 26/9/2008 327,913

Worldcom, Inc.^1 21/7/2002 103,914

General Motors Corporation 1/6/2009 91,047

CIT Group Inc. 1/11/2009 80,448

Enron Corp.^2 2/12/2001 65,503

Conseco, Inc. 17/12/2002 61,392

MF Global Holdings Ltd. 31/10/2011 40,541

Chrysler LLC 30/4/2009 39,940

Thornburg Mortgage, Inc. 1/5/2009 36,521

Pacific Gas and Electric Co. 6/4/2001 36,152

Texaco, Inc. 12/4/1987 34,940

Financial Corp. of America 9/9/1988 33,864

Refco Inc. 17/10/2005 33,333

IndyMac Bancorp, Inc. 31/7/2008 32,734

Global Crossing Ltd. 28/1/2002 30,185

Bank of New England Corp. 7/1/1991 29,773

General Growth Properties, Inc. 16/4/2009 29,773

Lyondell Chemical Company 6/1/2009 27,392

Calpine Corp. 20/12//2005 27,216

1 Worldcom, Inc. assets taken from the audited annual report dated 31/12/2001.

2 The Enron assets were taken from the tax documents filed on 19/11/2001. The company has announced that the financials were under review at the

time of filing for Chapter 11.

Source: New Generation Research, Inc. http://www.bankruptcydata.com.