Del HawleyFIN 634.ppt

Chapter 13: Overview 13.1. Costs of Bankruptcy and Financial Distress What Makes Bankruptcy Costs Matter? Asset Characteristics and Bankruptcy Costs Direct and Indirect Costs of Bankruptcy International Differences in Bankruptcy Costs 13.2. Agency Costs and Capital Structure Using Debt to Overcome the Agency Costs of Equity Agency Costs of Outside Debt The Agency Cost/Tax Shield Trade-Off Model 13.3. The Pecking Order Hypothesis of Corporate Debt Assumptions Underlying the Pecking Order Hypothesis Limitations of the Pecking Order Hypothesis Chapter 13: Overview 13.4. Signaling Models of Corporate Leverage How Capital Structure Signaling Convey Information Empirical Evidence on Capital Structure Signaling 13.5. Developing a Checklist For CS Decision-Making Leverage Operating / Financial Variables Relationships Leverage Ownership Structure Variables Relationships Leverage Macroeconomic / Country Variables 13.6. Summary Bankruptcy Risk Doesn’t Impact Capital Structure--Unless It Is Costly Costs Of Financial Distress Direct costs of bankruptcy (out-of-pocket cash expenses) Legal, auditing and administrative costs (include court costs) Large in absolute amount, but only 1-2% of large firm value Indirect costs: Usually much more important Impaired ability to conduct business (e.g., lost sales) Managerial distraction, loss of best (most mobile) personnel Financial distress also gives managers adverse incentives Asset substitution problem: Incentive to take large risks Under-investment problem: S/Hs refuse to contribute funds Trade-off Model of Corporate Capital Structure Trade off tax benefits of debt vs costs of Financial distress: Game #1: The Asset Substitution Problem When a firm falls into financial distress, has incentive to play two damaging “games”. First is known as asset substitution Assume Firm Substitute has debt with a face value of $12,000,000 outstanding that will mature in one month. Only has $10,000,000 of cash on hand n