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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(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.
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.
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).
(See Myers (1977, 1984) and Williamson, 1988.) 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.(1)
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.

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