Moreover, our paper expands the large body of literature that explores the indirect costs of financial distress
(see, for example, Opler and Titman, 1994; Andrade and Kaplan, 1998).
These behaviors lead to indirect costs of financial distress
, discouraging leverage and reducing overall firm value.
First, indirect costs of financial distress
are likely to be much larger than the direct costs associated with bankruptcy (see, for example, Altman, (1984).
Some new proxies are proposed for the costs of illiquidity and the indirect costs of financial distress
. These include Tobin's q, R&D and advertising expenditures, an index of asset specificity and an index of the probability of bankruptcy.
In this section, I have discussed a number of ways in which the careful design of financing structures in LBOs can reduce the expected direct and indirect costs of financial distress
. As an empirical matter, however, relatively little is known about how frequently these approaches to financial design are used.(7) Moreover, even when used, these financing methods may turn out not to have the desired effect.