Bankruptcy Costs Research Articles

Stabilizing financial networks via mergers and acquisitions

A bi-level model is proposed to explore efficient policies for supporting negotiations on financial crisis resolution. In a principal–agent framework, this model minimizes the welfare loss function of a central authority (social planner, SP) through the simultaneous choice of subsidy levels and potential pairs of banks to merge. The SP’s choice of mergers needs to be incentive-compatible with the autonomous choices of banks, and the evaluation of the financial network must adhere to standard accounting principles. Incentive compatibility is enforced by two options for conditions, based on stable matching or competitive bidding. For the evaluation of the financial network, we employ an extended Eisenberg-Noe clearing payment equilibrium by considering bankruptcy costs and the seniority levels of liabilities. Additionally, liabilities are not cleared among solvent banks, and corporate bonds may be used for clearing payments. The bi-level model specifies conditions for the clearing equilibrium. For demonstration, we use major European banks, and a scenario linked to the adverse economic conditions used in the 2016 EU-wide stress testing.

Debt and taxes: the role of corporate group structure

Abstract I show that the corporate group structure generates tax benefits that create incentives for higher leverage. The tax benefits arise when losses on distressed subsidiaries are tax deductible for a parent firm. Higher tax rates then imply that more of these losses are borne by the government instead of the parent firm, reducing the expected costs of bankruptcy and thereby incentivizing the subsidiaries to take on higher leverage. Using data from a large sample of European multinationals, I show that this tax benefit exists on top of the trade-off theory and debt-shifting effects, and is stronger when deductions of subsidiary losses are more generous.

Capital structure determinants of small and medium enterprises in Mogadishu, Somalia

The aim of this study is to examine the factors influencing the capital structure of small and medium enterprises (SMEs) in Mogadishu, Somalia. The study applies the trade-off theory, which posits that several characteristics affect how firms finance themselves. According to this theory, firm size, which serves as a proxy for bankruptcy costs, positively influences capital structure—larger firms face lower bankruptcy risks. The research employed a descriptive correlation research design and utilized a stratified random sampling technique to gather data through questionnaires. Data analysis was conducted using the Statistical Package for Social Sciences (SPSS version 20). The study identifies three independent variables—profitability, cultural factors, and firm size—as crucial indicators of capital structure for SMEs in Mogadishu. These factors are pivotal as SMEs expand and initiate new operations. Interestingly, the perceptions or beliefs of owner-managers have little impact on capital structure decisions, while network linkages do not significantly influence SMEs' capital structure. It underscores the responsibility of SME owners and management to ensure their financial structures are optimally managed. The study highlights profitability as a significant factor affecting capital structure. In the absence of profits or insufficient profitability, businesses may struggle to survive as investors seek returns that ensure capital growth over time. Profitability thus plays a critical role in the long-term sustainability of a company.

Personal bankruptcy costs, union bargaining power, and capital structure

We document that employee bankruptcy costs affect corporate capital structure decisions via their impact on the bargaining power of labor unions. We employ difference-in-differences and triple-difference research designs surrounding a major bankruptcy reform that increased personal bankruptcy costs. Our results suggest that, on average, this reform reduced unions’ bargaining power, resulting in a decrease in the financial leverage of unionized firms relative to nonunionized firms. Our results provide new evidence for a relatively unexplored determinant of capital structure—personal bankruptcy costs.

Labor protection and financing decisions of firms: The case of China

Increased labor costs enhance the human capital costs of bankruptcy and operating leverage, inducing a firm to reduce its financial leverage. Serfling (2016), among others, examines and finds support for the hypothesis. Using a sample of Chinese firms affected by 2008 stricter labor laws, we find evidence to support our hypothesis that non-SOEs, facing higher firing costs than their SOE (State-owned enterprises) counterparts, decrease their financial leverage significantly more than SOEs. Our experiment avoids some econometric shortcomings that creep into the Serfling study.

Digitalization and firms' debt maturity: Do financial constraints and uncertainty matter?

Despite the significant growth of information and communication technology adoption in industrial activity, there is still limited evidence discussing the role of industrial digitalization in firms' debt structures. Therefore, the purpose of this study is to investigate the impact of digitalization on debt structure by employing a sample of Chinese manufacturing companies from 2001 to 2019. The results show that digitalization expands the proportion of firms' long-term debt. Further analysis reveals that digital technology superiority contributes to lowering bankruptcy costs, enabling firms to maintain longer debt maturity to manage liquidity and refinancing risks effectively. This research also finds that financially constrained firms derive greater advantages from digital transformation. Furthermore, the uncertainty risks appear to reduce the positive impacts of digitalization on firms' debt maturity.

Bankruptcy social cost, government intervention and stock price crash risk

This paper examines the relationship between the social cost of bankruptcy and the risk of corporate stock price collapse through a study of China's A-share non-financial listed companies from 2012 to 2022. It is found that the higher a firm's social cost of bankruptcy is, the lower its firm share price crash risk is instead. In addition, the extent to which the social cost of insolvency affects the risk of firm share price collapse is enhanced in regions with less government intervention.

Shareholder-Creditor Conflict and the Resolution of Financial Distress

Abstract Constructing a comprehensive data set of financially distressed firms that restructured their debts from 2000–2014, we find that firms with financial institutions’ loan-equity simultaneous holdings are more likely to restructure out of court than to file for bankruptcy. The effect is stronger when loans are oversecured and when the expected bankruptcy costs are larger. We use mergers of financial institutions and instrumental variable estimations to address potential endogeneity concerns. Firms with simultaneous holdings experience higher stock returns. The evidence suggests that mitigating shareholder-creditor conflict results in cost-effective resolutions of financial distress. (JEL G20, G30, G33)

Managerial ownership and labor income share

This paper investigates the influence of executive compensation on labor income share. I expect that higher managerial shareholding reduces labor income share. Consistent with this conjecture, the empirical evidence suggests that both augmented innovation investment and alleviated bankruptcy costs explain the reduction in labor income share. Our results remain robust by addressing the potential unobserved variable concerns and reverse causality issues. Heterogeneity tests show that the effect is more pronounced in firms with weaker political connections, higher institutional ownership, higher customer concentration, and in state-owned firms. This study contributes to the merging literature on the lowering of labor income share.

Corporate Borrowings: A Conceptual Perspective

In the dynamic landscape of global business and finance, corporate borrowings play a crucial role in addressing firms' capital needs, promoting economic growth, and facilitate expansion (Levine, 2003) amidst ever-changing global business and financial scene. Corporate borrowings are essential in forming the financial frameworks of companies in all sectors of the economy. The borrowings, as a source of capital, are considered by the corporate due to limitation of equity capital such as higher risk association from the investors’ perspective and high cost of capital from the company perspective. Borrowings include debt securities, loans, and other credit instruments. Corporations strategically decide whether to leverage borrowed capital in order to maximise their capital structure (Rocca et al., 2011), manage risk (Eunju & Jang SooCheong, 2005), and take advantage of growth prospects (Zhang & Wu, 2017). It is because of the fact that borrowings hold an ambivalent status of acceptance among the corporate. In one hand, borrowings bring benefits to a firm in the form of tax shield effect and less costly capital thereby enhancing shareholders value. On the contrary, it brings many costs to a firm like bankruptcy cost, financial distress etc. So, when making financial decisions, managers carefully examine the option of corporate borrowings as a critical source of funding.
 The recent emphasis on environmental sustainability by the Govt. and corporate, has led emphasis on the raising capital through green bond by the corporate that contribute positively to the climate or environment. Further, the concept of ESG (Environmental, Social and Governance) performance of the corporate has now dragged the attention of the investor as a measure of good corporate citizenship and thereby enabling the corporate to raise less costly capital through borrowings.
 In a time of economic uncertainties, technological advancements, and evolving paradigms in financial markets, it is critical to comprehend the corporate borrowings. Hence, this paper aims to give a thorough overview of corporate borrowings by exploring the various facets that characterise this important component of contemporary financial ecosystems.
 Further, this paper navigates across the potential benefits and theories which affect corporate financing decisions. On this investigation of corporate borrowings, we aim to provide valuable insights for scholars, policy makers, and industries. The remainder of this paper deals with importance, theories, cost, benefits, and determinants of corporate borrowings and last section provides the conclusion.

Trade‐Off Theory for Dual Holders

AbstractA dual holder simultaneously owns (private) debt and equity in the same firm. Private debt has a tax advantage, a positive cashflow, which incentivizes its use. This cashflow leads to a lower net cost of debt, which again reduces default risk as well as the cost of external debt. The usual trade‐off between tax benefits and bankruptcy costs is altered. Debt priority affects both financing and default decisions. We find that an enterprise‐value maximizing firm should issue senior, external debt and junior, private debt, rather than debt with pari‐passu priority. Our analysis further highlights that tax authorities can effectively curtail the tax‐motivated use of private debt through straightforward measures.

Analysis of Zombie Enterprises' Retention and Departure Based on Game Theory

Zombie enterprises, predominantly found in state-owned heavy industries and labor-intensive sectors, have emerged as a crucial challenge in recent years' supply-side structural reforms. To address this issue, this study constructs an evolutionary game model involving enterprises, banks, and the government. By employing replicated dynamic equations, the analysis examines the impact of factors such as the cost of enterprise exit, implicit benefits after bankruptcy, on the decision-making of enterprises to stay or exit. The research indicates that the cost of continuing operations for zombie enterprises, bankruptcy costs, corporate income tax rates, the magnitude of implicit benefits from continuing operations, bank loan interest rates, and the expected returns from diverting loan amounts to other purposes can influence the outcomes of the game. Ultimately, from a government perspective, relevant recommendations are proposed to provide insights into effectively addressing the problem of zombie enterprises.

Consistent valuation: extensions from bankruptcy costs and tax integration with time-varying debt

Consistent valuation: extensions from bankruptcy costs and tax integration with time-varying debt

Venture capital directors and corporate debt structure: An empirical analysis of newly listed companies

We investigate how venture capitalists (VCs) serving as directors on corporate boards affect portfolio companies’ debt structure after initial public offerings (IPOs). Using hand-collected data, we find that companies with a higher fraction of VC directors on their boards use significantly fewer types of debt. The impact of VC directorships on debt concentration is more pronounced in companies facing greater expected bankruptcy costs or higher degrees of uncertainty. We further explore the benefits of debt concentration and find that a highly concentrated debt structure is associated with better corporate performance in companies with VC directors. Taken together, our evidence suggests that VC directors influence newly listed companies to adopt a concentrated debt structure, thus minimizing the risk of distress and enhancing company value. Our results are robust to accounting for endogeneity and sample selection bias.

Corporate net working capital: evidence from Shariah compliance

PurposeThis paper examines the influence of Shariah compliance (SC) on firms' net working capital (NWC) target and adjustment speed.Design/methodology/approach The study samples of non-financial firms taken from six Gulf Cooperation countries between 2005 and 2019 and employs static and dynamic models to answer the present study research questions.FindingsThe outcomes of the study indicate that SC is one of the major determinants of the decision made by the corporation regarding their NWC. More specifically, enterprises that are compliant with restrictions within Shariah are seen to have laid targets of their NWC at a level that exceeds that of enterprises that are not compliant. Furthermore, compared to conventional firms, they seem to have higher speed when adjusting to meet set NWC targets. Submission to Islamic laws limits the choices from which an enterprise can outsource capital from existing funding instruments. Therefore, they experience a higher expected cost of bankruptcy. That being the case, such financial managers should readily maintain and adjust to higher NWC targets to meet current corporate needs, alleviate the risk of bankruptcy and lower dependency on expensive external funding options.Originality/valueTo the authors’ knowledge, this is the first study to explore the influence of SC on firms' NWC target and adjustment speed.

The influence of crises on the financial position of multinationals in emerging markets

ABSTRACT This investigation is one of the first to analyse the relationships between leverage and bankruptcy costs, interest expenses, tax benefits and firm value, in multinational and domestic companies, during periods of crisis and financial stability. The analysed data are related to the Organisation for Economic Co-operation and Development’s (OECD) most important emerging markets (Brazil, China, India, Indonesia, and South Africa) based on a sample of 15,632 observations from public companies for the period 2004–2019 (including the 2008 crisis). The results suggest that multinational companies incur lower bankruptcy costs than domestic ones. Meanwhile, they also become more valuable. Another difference relates to multinationals’ ability to raise their leverage levels, even in times of crises, in contrast to domestic companies. Multinational companies also exhibit higher financial negotiation power and may obtain lower interest rates than domestic companies. These findings contribute to the understanding of the financial dynamics demonstrated by multinationals and domestic companies in emerging economies during periods of crisis and stability.

Employee Costs of Corporate Bankruptcy

ABSTRACTAn employee's annual earnings fall by 13% in the first full calendar year after her firm's bankruptcy, and the present value of lost earnings from bankruptcy to six years following bankruptcy is 87% of pre‐bankruptcy annual earnings. More worker earnings are lost in thin labor markets and among small firms. Ex ante compensating wage differentials for this “bankruptcy risk” are up to 2% of firm value for a firm whose credit rating falls from AA to BBB, comparable in magnitude to debt tax benefits. Thus, wage premia for expected costs of bankruptcy are sufficiently large to be an important consideration in capital structure decisions.

Effect of bankruptcy costs on value of firms listed in Nairobi securities exchange

This study measured the effect of bankruptcy costs on the value of the firm . Financial statements of listed firms for the period of 10 years 2008- 2017 were used. The study was anchored on the Traditional theory which emphasizes on optimality of a capital structure. This study was guided by positivisim research philosophy due to its power of applting deductive logic in arriving at meanings. Asample of 40 firms which have been consistently quoted during the entire study period of 2008-2017 was used. A data collection sheet was used to extract secondary data from published financial statements. Peer reviews were done to unsure face validity while expert opinion ensured content validity. Data was analyzed using descriptive statistical methods of minimums, maximums, mean, percentages and standard deviation. Further Karl Pearson correlation coefficient and backward regression techniques were adopted in analysing the panel data. The results were presented in the form of summarised tables and graphs. The findings revealed bankruptcy costs and had significant effect on value of the firms listed in Nairobi Securities Exchage. It was recommended that information symmetry could be enhanced through close monitoring of compliance to corporate governance practices particularly on disclosure requirements.

Credit default swaps and debt specialization

We examine the effect of credit default swaps (CDSs) on debt specialization. We argue that reference firms in CDS contracts, seeking to minimize creditor conflicts and bankruptcy costs, exhibit higher debt concentration than firms on which no CDSs are traded. Our results show that firms engage in greater debt specialization and are more likely to specialize following the inception of CDS trading. Additionally, we find that, while lender concentration in firms increases, the number of bank lenders drops, lead arranger share rises, and the probability that lead arrangers and lenders are repeated increases following the onset of CDS trading. Our results are robust to instrumental variable estimation, propensity-score matching, different model specifications, and different subsamples.

Creditor-controlled insolvency and firm financing– Evidence from India

Using the ‘Insolvency and Bankruptcy Code’ (IBC) in India, we show that, despite an increase in the supply of credit, IBC led to a higher reduction in the secured debt of the high tangibility firms compared to the low tangibility firms. We also find that secured debt was substituted with other sources like equity, retained earnings, and accounts payable; more cash was held back. Our findings suggest that managers’ expected cost of bankruptcy obstructed the expected increase in supply of credit after IBC. We add to the mixed evidence on the impact of creditor rights on firm's financing decisions.