Costs Of Financial Distress Research Articles

PENGARUH INVESTASI DAN PENDANAAN TERHADAP BIAYA MODAL PERUSAHAAN DAN FINANCIAL DISTRESS PERUSAHAAN TAMBANG BATUBARA YANG GO PUBLIC DI INDONESIA

The purpose of this study to analize and determine the effect of investment and funding to the cost of company capital and financial distress. The development of mining and mining service comnaies that go public today reached 42 companies in Indonesia in the period 2013-2015, including examined 23 financial statement of coal mining companies at the same time.Using regression path analysis methode to test the magnitude of the effect indicated by the path coefficient on each path diagram of the causal relationship between investment decision and funding decision as exogenous variable to cost of campany capital and financial distress as endogenous variable.The results showed that investment decisions and funding decisions significantly affect the cost of company capital; Investment decisions have a significant and dominant effect on financial distress and have a negative and insignificant effect on financial distress through the cost of company capital; Funding decisions have a negative and insignificant effect on financial distress and have a significant effect on financial distress through the cost of company capital; The cost of company capital has a negative and insignificant effect on financial distress.

A Precisely Practical Measure of the Total Cost of Debt for Determining the Optimal Capital Structure and the Weighted Average Cost of Capital

This paper develops a precise method of estimating the cost of debt to a firm that is based on standard financial theories and empirical evidence on default risk and financial distress costs. An analysis with current data on the S&P 500 demonstrates that the capital structures of large firms are consistent with the model's simple implications.

The cost of capital effect of M&A transactions: Disentangling coinsurance from the diversification discount

AbstractThis study argues that in corporate diversification there is a bright side (coinsurance effect) and a dark side (diversification discount). While diversification might reduce systematic risk by its impact on the cost of financial distress, it might increase systematic risk because of inefficient cross‐subsidization at the same time. Building on an extension of the model of Hann, Ogneva, and Ozbas (), we analyze mergers and acquisitions in the US over the period 1985 to 2014. We find the coinsurance effect to decrease the cost of capital by 36 basis points for the average firm. However, at the same time, we observe a 7 basis points increase in the cost of capital related to the inefficiency of the firm's internal capital market. Both effects are statistically significant and robust to endogeneity concerns, different empirical specifications, and variable measurement.

Employment protection and corporate cash holdings: Evidence from China's labor contract law

Abstract Employment protection increases labor adjustment costs and hence the expected costs of financial distress for labor-intensive firms. It follows that these firms are likely to increase their cash holdings to reduce the risk of financial distress when employment protection is strengthened. Consistent with this prediction, we find that labor-intensive firms in China significantly increase their cash holdings following the enactment of China's Labor Contract Law; other contemporaneous shocks do not seem to drive the finding. We also find that two events prior to the enactment that increase the likelihood of enacting the law have a similar effect. Further analysis shows that the impact of the law is concentrated on areas with strict law enforcement, state-owned enterprises, and industries that employ large numbers of migrant workers.

Bankruptcy reforms in the midst of the Great Recession: The Spanish experience

We make use of a unique data set of corporate insolvencies in Spain to assess the effectiveness of the four reforms to the Spanish bankruptcy code implemented during the Great Recession (2008–2013). One of the reforms decreased the average duration of insolvency procedures by increasing the appeal of private workouts as an alternative to formal bankruptcy. Two of the reforms increased the percentage of reorganisations by increasing the quality of insolvency administrators and reducing the costs of financial distress. The impact was larger in firms with lower liquidation values and higher going concern values, suggesting an increase in ex-post efficiency. By contrast, two of the reforms did not achieve their goals and failed to have any robust impact on those dimensions. Our research illustrates the important role that insolvency administrators may play in the design of an efficient bankruptcy system, as well as the need for a legal framework that supports out-of-court workouts as an alternative to formal bankruptcies. More generally, our results highlight the importance of evaluating bankruptcy reforms before assessing their impact on other dimensions such as credit, firm financing and investment.

Corporate bond clawbacks as contingent capital for banks

We propose a contingent clawback bond (COCLA) as an alternative source of contingent convertible capital (CoCo). We develop a utility maximization model in which a bank manager faces the following two trade-offs: one trade-off is between the private benefits of control and costs of financial distress when loans under-perform, and the other is between the costs and benefits of screening loan credit quality (effort). In our model, the supply of loans, amount of junior debt issued, level of effort exerted by a manager, and manager's decision to exercise the clawback option are endogenously determined in the maximization of the manager's utility function. We find that the manager optimally exercises the clawback following a low realization of cash flows, thereby solving the trigger problem presented in CoCos. In the model, the debt to equity conversion from the COCLA is an endogenous decision, the regulatory capital adequacy ratio (CAR) is satisfied, and the bank does not face distress costs. From a practical perspective, the conversion rate for the COCLA that jointly maximizes the manager's expected utility and stock holders’ pay offs is around 25%, a rate close to the typical percentage (30%–35%) that is often found in initial public offering clawback (IPOC) contracts used in the corporate world.

Cash holdings in SMEs: speed of adjustment, growth and financing

This paper studies the effect of growth opportunities, financial constraints and financial distress on the speed of adjustment of small and medium-sized enterprises (SMEs) to their target cash holdings. We use a sample of Spanish SMEs from the period of 1998 to 2012. The results support the existence of a target cash holding level to which small firms attempt to converge. Additionally, consistent with the precautionary motive for cash holdings, the results show that SMEs with greater growth opportunities adjust more quickly to their target cash holding level to preserve their financial flexibility and to be able to take advantage of profitable investment opportunities when they arise. Moreover, for SMEs in financial difficulties, the adjustment speed of cash is higher to avoid financial distress costs. Finally, we observe a faster speed of adjustment for cash holding in the crisis period for all firms, as a possible response to the credit restrictions faced by SMEs.

Do Firms Hedge in Order to Avoid Financial Distress Costs? A Theoretical Approach with Empirical Evidence for German Corporates

We present a new approach to test the financial distress costs theory of corporate hedging empirically. We estimate the ex ante expected financial distress costs, which serve as a starting point to construct further explanatory variables in an equilibrium setting, as a fraction of the value of an asset-or-nothing put option on the firm’s assets. Using single-contract data of the derivatives’ use of 189 German middle-market companies that stems from a major bank as well as Basel II default probabilities and historical accounting information, we are able to explain a significant share of the observed cross-sectional differences in hedge ratios. Hence, our analysis adds further support for the financial distress costs theory of corporate hedging from the perspective of a financial intermediary.

English

This study aims to identify a number of qualitative and quantitative elements that affect financial distress costs between Italian and German small and medium-sized enterprises (SMEs). We propose a model that interprets “expected costs” as the product between “expected financial distress likelihood” and “total amount of financial distress costs due to insolvency”. The model is estimated using panel data methodology on samples from two European countries (Italy and Germany). The results indicate that expected costs depend on the use of derivative financial instruments, use of intangible assets and the relation with local banks (small local banks rather than large banking groups); in particular, the results obtained from cross‐country comparison shows that German SMEs (or Mittelstand companies) have characteristics that limit financial distress costs. It should be emphasized that the present work limits its field of investigation to a few variables without fully addressing other elements of uncertainty which may adversely affect the expected cost of financial distress in SMEs. This work will be useful to stimulate debate on policies to support SMEs. The originality of this study is to focus on determinants of financial distress in SMEs using panel data methodology. Key words: Cross‐country comparison, derivative instrument, expected cost, financial distress, small and medium-sized enterprises (SME).

Evaluation of financial distress costs of innovative companies

Over the last few decades investments in research and development (R&D) projects have risen significantly. Many experts have found a positive relationship between R&D expenses and a company’s value. However, investments in innovations are characterized by a high level of uncertainty. Often innovations generate income only in long run. These factors increase the probability of firms’ financial distress considerably. Thus, the aim of the present paper is to evaluate financial distress costs at companies that invest in research and development projects. The study covers 389 innovative firms over the period from 2006 to 2015. The analysis is based on a direct and indirect costs evaluation. The first are estimated through panel logistic regression. Indirect costs are calculated as unexpected losses or profits relative to industry indicators. The paper confirms the existence of relation between R&D expenses and financial instability. The results of the research show that the total financial distress costs of innovative companies amount to 7.95% of total assets or 11.78% of the value of a company on average.

Corporate Refinancing, Covenants, and the Agency Cost of Debt

How valuable are restrictive debt covenants in reducing the agency costs of debt? I exploit the revealed preference decision to refinance fixed-coupon bonds, which weighs observable interest rate savings against the unobservable costs of a change in restrictive covenants. Variation in this trade-off reveals that firms require higher interest rate savings to refinance when it would add restrictive covenants. I structurally estimate a model of debt refinancing and find that a high-yield bond's restrictive covenant package increases the value of speculative-grade firms by 2.4 percent. This suggests that covenants are essential for allowing the tax benefits of debt to offset costs of financial distress.

Dynamic Risk Management of Commodity Operations: Model and Analysis

Adverse commodity prices can cause significant negative cash flows and expose firms that deal in commodities to financial distress. In this paper we consider the dynamic risk management problem for a commodity processor operating in a partially complete market, facing both price uncertainty and significant financial distress costs. The firm procures an input commodity, processes it to produce an output commodity, and trades the output commodity in each period over a multiperiod horizon. The firm’s objective is to dynamically and jointly plan operational and financial hedging decisions to maximize the market-based value of cash flows under a time-consistent risk measure. We show that the optimal operational policy has the same price and horizon dependent threshold structure that obtains when markets are complete. We also characterize conditions under which a myopic policy is optimal. We present numerical studies to illustrate that (i) compared to using a myopic policy or a policy that neglects to model financial distress costs, the advantage of using the optimal policy is significant for firms that face moderate financial distress costs and have excess procurement capacity; (ii) more acute financial distress costs reduce the firm’s market-based value and throughput; and (iii) financial hedging provides considerable benefit by reducing the incidence of large negative cash flows. The online appendix is available at https://doi.org/10.1287/msom.2017.0647 .

Scope, measurement, impact size and determinants of indirect cost of financial distress

PurposeThe purpose of the study is to systematically review the literature of indirect cost of financial distress to understand its scope, measurements, impact size and determinants to synthesis with future research agenda.Design/methodology/approachFive-step process of systematic literature review (SLR) as applied by Opoku et al. (2015) is used. SLR extracted 47 studies of indirect cost after applying specified search criteria. Data regarding measurement, impact size and determinants are presented and summarised in specified tables.FindingsSLR showed that the study of indirect cost in developing countries is a literature gap. It is also found that opportunity loss, operating profit loss, market loss and risk premium are most studied indirect costs using legal definition or ex ante proxy of financial distress. However, future studies are recommended to use both non-linear leverage and ex ante proxy of financial distress. Future studies are also suggested to use the moderation technique while studying the determinants of indirect cost.Research limitations/implicationsLiterature selection is based on specific search criteria that can miss some of the other related literature.Originality/valueThe indirect cost of financial distress is more costly and difficult to measure due to its complex concealed effects. A detailed literature of indirect cost is needed to understand the construct that eventually will help to define the future research agenda. To the best of the authors’ knowledge, no SLR of indirect cost is provided yet. Therefore, the outcome of this research will be valuable for both academicians and practitioners.

Employment Protection and SME Capital Structure Decisions

This study examines the effect of employment protection (EP) on the capital structure of SMEs. We argue that EP is linked to both the level of leverage and leverage adjustments because of its impact on financial distress costs and a firm's operational leverage. Data on employment contract types allow us to compose company specific measures of exposure to EP using a panel data set of 14,858 Belgian SMEs between 2000 and 2012. Our results show that the leverage ratio of firms is higher and that firms are more likely to adjust leverage levels when they are subject to fewer EP obligations.

Employment Protection and Corporate Cash Holdings: Evidence from China's Labor Contract Law

Employment protection increases labor adjustment costs and hence the expected costs of financial distress for labor-intensive firms. It follows that these firms are likely to increase their cash holdings to reduce the risk of financial distress when employment protection is strengthened. Consistent with this prediction, we find that labor-intensive firms in China significantly increase their cash holdings following the enactment of China’s Labor Contract Law; other contemporaneous shocks do not seem to drive the finding. We also find that two events prior to the enactment that increase the likelihood of enacting the law have a similar effect. Further analysis shows that the impact of the law is concentrated on areas with strict law enforcement, state-owned enterprises, and industries that employ large numbers of migrant workers.

Imperfect Renegotiations in Interbank Financial Networks

Interbank financial networks enable banks to share the risks in their assets but potentially also increase systemic spillovers of insolvency from one bank to others in the network. We model a renegotiation game to explicitly examine the forgiveness of commitments of insolvent banks by solvent banks to limit the systemic transmission of financial distress. The assets of the insolvent bank can be appropriated by the forgiving bank in the two-bank network, but not the three-bank network, where they may be appropriated by the third bank, leading to a renegotiation breakdown. We also show how banks can ex ante optimally construct networks from interbank loans and derivatives to minimize the costs of such inefficient financial distress. This paper was accepted by Itay Goldstein, finance.

Bloomberg Intelligence Roundtable on The Theory and Practice of Capital Structure Management

Since the formulation of the M&M propositions almost 60 years ago, financial economists have been debating whether there is such a thing as an optimal capital structure—a proportion of debt to equity that maximizes shareholder value. Some finance scholars have followed M&M in arguing that both capital structure and dividend policy are largely “irrelevant” in the sense that they have no significant, predictable effects on corporate market values. Another school of thought holds that corporate financing choices reflect an attempt by corporate managers to balance the tax shields and disciplinary benefits of greater debt against the costs of financial distress. Yet another theory says that companies do not have capital structure targets, but simply follow a financial “pecking order” in which retained earnings are preferred to outside financing, and debt is preferred to equity when outside funding is required.In this roundtable, a leading finance professor is joined by six practitioners in discussing whether and how capital structure decisions and payout policies can create value, with special attention to the healthcare industry. The consensus is that for those parts of the pharma industry with large growth opportunities, equity financing should be the main source of capital. But for those parts of the industry with shrinking prospects, increasing levels of debt and raising dividends are recommended.

Financial distress cost of Italian small and medium enterprises

PurposeThis paper aims to propose a theoretical model designed to predict the likelihood of financial distress of an enterprise and to quantify the damages whenever the financial crisis became full-blown.Design/methodology/approachCoherently with the objectives of the paper, the analysis considers the last seven exercises (period: 1999/2006) of a sample of 25.000 small- and medium-sized enterprises (SMEs) (volume of sales: < 20 mlns; number of employees: < 250) organized in the form of Ltd. The empirical investigation has been affected through the use of BvD database: Aida and Mint Italy.FindingsThe analysis shows that the ex post costs of financial distress decrease in relation to the company’s increased ability to use intangible assets and in relation to the local roots of the banks (local banks rather than international banking groups).Research limitations/implicationsThe instruments used for this study need to be subjected to more statistical tests to establish a more robust validity and reliability. Replication of this study using larger samples and a broader geographic base (extended at European level) is suggested.Practical implicationsThe timely monitoring of investigated variables allows you to mitigate the costs of exit from the market.Originality/valueFollowing the global financial crisis, this paper sheds new light on the financial distress cost of Italian SMEs.

The effect of financial distress costs on ownership structure and debt policy

PurposeThe purpose of this paper is to examine the effect of financial distress costs, corporate growth rate, and flexibility on the interaction between ownership structure and corporate debt policy.Design/methodology/approachThe authors test the hypotheses by employing simultaneous equations system methodology with two-stage least squares regression and panel data technics on a sample of 786 listed companies on the Tehran Stock Exchange during 2010-2015.FindingsThe results indicate that there is a positive and significant relationship between corporate debt level and managerial ownership in the Iranian listed companies. The authors also find no convincing evidence that either the firm’s growth or financial health could influence or moderate this interrelationship.Research limitations/implicationsThe implications drawn from this study are constrained by two primary limitations. First, the present study is conducted in an Iranian setting; therefore, the data utilized for the study only contain companies listed on the Tehran Stock Exchange. The utilization of listed companies on the Tehran Stock exchange is likely to affect the generalizability of the study in a national context. Second, the authors were unable to extend the sample time period due to some major deficiencies in the Tehran Stock Exchange library and its supplementary software.Social implicationsSince the fundamental institutional assumptions underpinning the western and even East Asia capital structure models are not valid in the institutional environment of Iran, the findings could provide substantial implications for our understanding of capital structures as well as debt policy literature.Originality/valueThis is an innovative research in terms of the mutual relationship between debt and ownership structure and the use of equations system to measure the interaction between them.

The Capital Structure: Is Debt just a Policy or Requerement?

1. Introduction The presence of debt started when Luca Pacioli introduced his accounting equation in interpretation that firms are obtaining their assets by using liabilities and equities. After years, debt always show up in most of firm's financial reports and generally attracting the investors in capital market. The existence of debt inflicting some questions in context of capital structure, such as is debt a requirement for most of firms in term to finance their investment activities in objective to achieve the target profit? or is debt just a policy for other intentions?. These issues about capital structure of the firms are still in debate around academicians especially in context of trade off theory and pecking order theory since debt has playing its own role which makes the capital structure still a puzzle (Myers, 1984; Nechaev and Antipina, 2016; Thalassinos et al., 2010; Vovchenko et al., 2017; Fetai, 2015). Myers (2001) proposes two conditional theories of capital structure for explaining why firms obtaining debt, which are trade off and pecking order. According to Myers (2001), in perspective of trade off, firms as tax payers generally shall look for optimum debt in term to get tax shield, while in perspective of pecking order, firms shall avoid debts if their internal fund such as retained earnings sufficient for financing their expenditures or investments (Boldeanu and Tache, 2016). In contrast, the findings by Baker and Wurgler (2002), Klein, O'Brien, and Peters (2002), Hovakimian, Hovakimian, and Tehranian (2004), Alti (2006), Elliott, Kant, and Warr (2008), Thalassinos et al. (2015), Allegret et al. (2016), Duguleana and Duguleana (2016) and Brendea (2012) show that the market timing hypothesis can become an alternative explanation about capital structures of the firms, where the valuations by investors for share prices in capital market shall trigger the effects of pecking order or trade off in flexible. As developing country, the Indonesia has many firms with various debt. Limited to the samples, based on data from Indonesia Stock Exchange (www.idx.co.id) the trends of average total debts to total assets ratio are 52.33% for year of 2011, 48.06% for year of 2012, 49.88% for year of 2013, 48.99% for year of 2014, and 50.25% for year of 2015. The trends show that the average of debt to asset ratios for firms in period of 2011 to 2015 are fluctuate in range of almost or even half by their total assets which means most assets of these firms are financed by debts. The study proceeds the next sections as follows, section 2 reviews the relevant literatures and hypothesis development. Section 3 presents the samples, variable definitions and the regression models. Section 4 presents the result and discuss the findings, and finally section 5 concludes the findings. 2. Literature Review 2.1. Trade off theory and pecking order theory Similar to Myers (2001), Elliott, Kant, and Warr (2008) propose that, the model of capital structure can be viewed in perspectives of two main theories which are trade off theory and pecking order theory. Moreover, Elliott, Kant, and Warr (2008) explain that, in perspective of pecking order theory, the firms shall choose the equities with lower cost of capital which implies that the firms shall finance their investments by use their internal funds then by external funds, while in perspective of static trade off theory, the firms in periodically shall adjust their capital structure until it reach the optimum portion. Sunder and Myers (1999) prove empirically that, the mature firms tend to adopt pecking order model in term to determine their capital structure rather than trade off model. Sunder and Myers (1999) also explain that, although debts shall give tax benefit to firms but the over debts shall make the firms bear the financial distress costs. According to Cheng and Shiu (2007), in view of pecking order theory, the existence of asymmetry information between insiders and outsiders makes firms use their internal fund rather than debts in term for financing the investments, and that why pecking order assumes the firms tend to decrease their debts when they get profit. …