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Financial Distress (Symptoms of Financial Distress (CEO resignation,…
Financial Distress
Symptoms of Financial Distress
CEO resignation
Reduced dividends
Falling share price
Losses
Job cuts
Store/plant closures
Responses to Financial Distress
Asset expansion - increase size of assets (e.g. acquistion, joint-ventures)
Operational contraction - focus on most profitable activities
Financial policies - e.g. reduced dividends, renegotiation of debt
External control activity - acquired or significant stake take by investors with more capital
Changes in managerial control
Wind up the company
Liquidation and Administration (Reorganisation)
Absolute Priority Rule - sets out the order in which proceeds are distributed
Administration
Restructure liabilities - e.g. exchange debt for equity
Look for a buyer
Break up into viable parts
Private Workout
Less costly
Doesn't allow debtor-in-possession debt
Harder with a lot of creditors
Formal Bankruptcy
Usually better for shareholders as allow renegotiation with creditors
Institutional environment impacts whether to go for formal bankruptcy or not - lenders or borrowers favoured
Pre-packaged Bankruptcy
Immediate sale of assets
Combination of private and formal
Emerges faster
Higher sale price due to goodwill due to continuation of operations
Preserves jobs by transferring employees to new firm
Causes of Financial Distress
High leverage ratio
Recession
Poor operating performance
Financial Distress - When operating cash flows are insufficient to cover current obligations
Insolvency - value of assets<value of debt (negative equity) or a cash flow shortfall