Financial Distress

Question 1

Opler and Titman 1994 JF

Answer 1

• In industry downturns high leverage firms lose out to low leverage rivals;
• reducton in market share and market value of equity and **sales. **
• Firms with specialized product especially vulnerable, R&D firms suffer the most.
• More pronounced in concentrated industries.

Question 2

Andrade and Kaplan 1998

Answer 2

• Key Method: sample comprised of 31 highly leveraged transactions (HLTs) that had good operating performance → weren’t economically distressed
• net effect of the HLT & financial distress (from pretransaction to distress resolution) is to increase value slightly → overall, the HLTs of the late 80s created value.
• estimate financial distress costs to be 10 to 20% of firm value
• For subset of firms that do not experience an adverse economic shock, financial distress costs are negligible.

Question 3

Pulvino 1998

Answer 3

• Use of Schiefer and Vishny 1992 (industry-equilibrium & asset liquidtion) suspect, per Kayhan
• financially constrained airlines receive lower prices (14% discount) than their unconstrained rivals when selling narrow-bodied aircraft
• Capital constrained airlines more likely to sell used aircraft to industry outsiders, especially during market downturns.
• Unconstrained airlines significantly increase buying activity when aircraft prices are depressed; this pattern is not observed for financially constrained airlines

Question 4

Zingales 1998

Answer 4

• Intuition: shock caused loss of (monopoly) trucking operating certificates → total asset value decreased → sudden leverage increase. Also shock increased risk in industry & threat of predation → *target* leverage decreased.
• Highly leveraged carriers are less likely to survive the deregulation shock, even after controlling for various measures of efficiency.
• effect is stronger in the imperfectly competitive segment of the motor carrier industry.
• High debt seems to affect survival by curtailing investments & reducing the price per tonmile that a carrier can afford to charge after deregulation.

Question 5

Brown and Matsa 2012

Answer 5

1. job seekers accurately perceive firms’ fin health, as measured by CDS prices
2. perceptions re fin firms’ postings during 07 crisis affect job seekers’ app decisions
3. incr in distress → in fwr & lwr quality applicants.
4. decline even when comparing apps to exact same positions before & after entering distress.
5. effects strongest in locations with crappy social safety net

Question 6

Davydenko, Strebulaev and Zhao 2012

Answer 6

• Motivation: update to Andrade & Kaplan 1998. More firms. Not restricted to HLTs, who may chose HL b/c of low distress costs. Unlike AK, find high fin distress costs even after controlling for economic distress.
• Intuition: Investors anticipate default only partially → def announce contains element of surpise → mkt val of firm’s debt & equity change ⇒ reflects cost of default & degree unanticipated
• Method: D + E = (1 - q)*V + q*(V - c), V asset value, q investor’s risk adj def prob, c cost of default. Evaluate q from historical defaults & debt prices → undo effect of partial anticipation of price reaction –> compute c
• Find: est cost of def for avg defaulting firm at 21.7% of mkt value of assets.
• costs vary from 14.7% for bond renegs to 30.5% for bankruptcies
• substantially higher for invest-grade firms (28.8%) than for highly levered bond issuers (20.2%)