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Summary of chapter 45 : Bankruptcy and restructuring |
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Bankruptcy is triggered when a company can no longer meet its short-term commitments and thus faces a liquidity crisis. This situation does not arise because the company has too much debt, but because it is not profitable enough. A heavy debt burden does no more than hasten the onset of financial difficulties.
Bankruptcy process is one of the legal mechanisms that is the less standardized and homogenized around the world. Virtually all countries have a different system. Depending on the country, the process will be either “creditor friendly” or “debtor (company) friendly”. But All processes have the same goals although they might rank differently: - pay-down the liabilities of the firm, - minimize the disruptive impact on the industry, - minimize the social impact.
Bankruptcy process can generate two types of inefficiencies: - allow restructuring of an inefficient firm that destroys value; - lead to liquidation of efficient companies.
Prior to court proceeding, a company experiencing financial difficulties can try to implement a restructuring plan. The plan generally includes a recapitalisation and renegotiation of the company’s debt.
Bankruptcy generates both direct (court proceedings, lawyers, …) and indirect costs (loss of credibility vis-à-vis customers and suppliers, loss of certain business opportunities, etc.). These costs have an impact on a company’s choice of financial structure.
Financial distress will generate conflict between shareholders and creditors (agency theory), and conflict among creditors (free riders issues).
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