Finacial Distress, Managerial Incentives, And Information Chap 16

Question 1

Default

Answer 1

When the firm fail to make the required interest or principal payments on the debt. After the film defaults, debtholders are given certain rights to the assets of the firm

Question 2

2 forms of bankruptcy

Answer 2

Liquidation and reorganisation

Question 3

Liquidation

Answer 3

Closing down the business and selling off all its assets

Question 4

Réorganisation

Answer 4

All pending collection attempts are automatically suspended, and the firms existing management is given the opportunity to propose a reorganisation plan.

Question 5

Direct cost of bankruptcy

Answer 5

Workout and pre-packaged bankruptcy

Question 6

Workout

Answer 6

A method for avoiding a declaration of bankruptcy, in which a firm in financial distress negotiate directly with its creditors to reorganise

Question 7

Prepackaged bankruptcy

Answer 7

A method for avoiding many of the legal and other direct cost of bankruptcy, in which a firm first develop a reorganisation plan with the agreement of its main creditors, and then files to implement the plan

Question 8

Indirect costs of financial distress

Answer 8

1. Loss of suppliers: they may be unwilling provide a firm with the inventory of they need in fear that they will not be be paid
2. Loss of employees: firms in distress cannot offer a job security with long-term employment contracts
3. Lots of receivables: firms in financial distress tend to have difficulty collecting money that is owed to them
4. Fire sales of assets: in an effort to avoid bankruptcy and its associated cost company in distress may attempt to sell assets quickly to raise cash
5. Inefficient liquidation : bankruptcy protection can be used by management to delay the liquidation of a firm that should be shut down
6. Cost to creditors

Question 9

Who pays for financial distress costs

Answer 9

When securities are fairly priced, the original shareholders of a firm pay the present value of the cost associated with bankruptcy and financial distress

Question 10

Trade off theory

Answer 10

The firm picks its capital structure by trading of the benefits of the tax shield from debt against the costs of financial distress and agency costs