The Resolution of Claims in Financial Distress the Case of Massey Ferguson CARLISS Y. BALDWIN and SCOTT P. MASON* WHEN A FIRMâS BUSINESS DETERIORATES to the point where it Cannot meet its financial obligations, the firm is said to have entered the state of âfinancial distressâ. The first signals of distress are usually violations of debt covenants coupled with the omission or reduction of dividends. Some financially distressed firms eventually go bankrupt: others recover or manage to settle the claims against them out of court.â The behavior of firms in financial distress is interesting for two reasons. First the âcosts of financial distressâ are an important element in capital structure theory. In many models,* these costs are hypothesized to counteract the tax benefits of leverage, and lead to an internal optimum for the capital structure of the firm. Second, financial distress has come to be recognized as a state in which contractual claims are incompletely specified. Standard terms of the debt-equity contract are violated when the firm enters financial distress, and claimants may then decide not to act according to previously agreed upon rules or legal formulas. Recent history has provided a number of examples of firms in
The Journal of Finance – Wiley
Published: May 1, 1983
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