Financial Distress Cost

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.
References in periodicals archive ?
Using long-term debt to benefit from tax advantage of debt--which has a positive impact as long as firms do not record the so called financial distress cost (12);
However, Mian (1996), Brown (2001) and Bartram, Brown, and Fehle (2009) find little evidence that the use of currency derivatives is related to financial distress cost. Further, even with hedging, some studies find that firms cannot eliminate their foreign exchange exposure as the potential effects of hedging on firm risk and firm value are small and most firms engage in currency hedging selectively (see, for example, Guay and Kothari, 2003; Hentschel and Kothari, 2001; Bodnar, Hayt, and Marston, 1998).
We define high (low) financial distress cost firms as the 250 firms with lowest (highest) Altman's Z-score.
(16) As financially distressed firm may lose customers, suppliers, and/or employees depending on the characteristics of their products and labor contracts for example, financial distress costs are also assumed to be heterogeneous across firms in Purnanandam (2008).
Besides, growth in financial independence could also find an interpretation in the family firms' willingness to minimise their financial distress costs, allowing them to perpetuate their activities in a period of economic contraction (Ward, Family Business Review, 1988; Kenyon-Rouvinez & Ward, Presse Universitaire de France, 2004).
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.
Branch (7002) in his review article writes "Clearly we have a wide range of estimates for financial distress costs." [Ben Branch (2002), "The Cost of Bankruptcy: A Review," International Review of Financial Analysis, vol.
Mitigation of Financial Distress Costs. Numerous authors have investigated whether firms more likely to incur financial distress costs engage in risk management in an effort to reduce the probability of incurring these costs.
Because MIPS is equity with an after-tax cost similar to that of risky debt, issuing this security and using the proceeds to retire outstanding preferred stock enables us to isolate the impact of tax savings on common share value without the confounding influence of financial distress costs. We hypothesize that redeeming straight preferred stock should lower the firm's weighted average cost of capital and raise firm value by the present value of tax savings.
These explanations suggest firms use derivatives to lower nondiversifiable costs that associated with market frictions, such as taxes, financial distress costs, and external financing costs.
Direct financial distress costs have previously been examined by many authors (see, e.g., Warner, 1977; Ang, Chua, and McConnell, 1982; Altman, 1984; Gilson, John, and Lang, 1990; Weiss, 1990; McMillan, Nachtmann, and Phillips-Patrick, 1991; Betker, 1995b; and Tashjian, Lease, and McConnell, 1996).
Such divestments allow a firm to avoid both direct and indirect financial distress costs. Direct costs cover, inter alia, legal and administrative expenses (Gilson et al., 1990; Weiss, 1990; Betker, 1995).

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