Financial distress costs

Financial distress costs

Legal and administrative costs of liquidation or reorganization. Also includes implied costs associated with impaired ability to do business (indirect costs).

Financial Distress Cost

The cost of liquidation. Financial distress costs include fees for lawyers and money needed to file paperwork. They also include the losses incurred from slowing or ceasing operations.
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We identify subgroups of firms that should be especially affected by financial distress costs, underinvestment, and managerial incentives to hedge.
Theory predicts that nonfinancial corporations might use derivatives to lower financial distress costs, coordinate cash flows with investment, or resolve agency conflicts between managers and owners.
The static trade-off model predicts that increasing the present value of tax savings without increasing financial distress costs will raise firm value.
If there are costs to using too much debt (for example, expected financial distress costs or personal taxes on interest income), then firms with the greatest benefit to shielding taxes (for example, firms facing higher income tax rates) should be the ones with the greatest incentives to use debt financing.
This paper provides evidence consistent with the theory that innovative financing methods used by highly levered firms control incentive problems of debt and in turn reduce expected financial distress costs.
A second response to high financial distress costs is to limit the use of debt financing.
The higher returns to financially distressed firms therefore appear to be an adjustment for reduction in financial distress costs.
Examining the relation between asset characteristics and capital structures is, however, complicated by the fact that a firm,s vulnerability to financial distress costs is unobservable.
Sample firms also attempt to reduce indirect financial distress costs by [TABULAR DATA FOR TABLE 1 OMITTED] minimizing the disruption in normal business activities that can accompany a traditional Chapter 11 filing.
The liquidity ratio is documented to be positively related to these proxies of financial distress costs.
In the random sample, interest-rate derivatives use is related, in the expected direction, to financial distress costs, external financing costs, and liquidity.
Direct financial distress costs have previously been examined by many authors (see, e.

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