The Resolution of Claims in Financial Distress the Case of Massey Ferguson

The Resolution of Claims in Financial Distress the Case of Massey Ferguson The Resolution of Claims in Financial Distress the Case of Massey Ferguson CARLISS Y. BALDWIN and SCOTT P. MASON* WHEN A FIRM’S BUSINESS DETERIORATES to the point where it Cannot meet its financial obligations, the firm is said to have entered the state of ‘financial distress’. 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.’ The behavior of firms in financial distress is interesting for two reasons. First the ‘costs of financial distress’ 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 http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Journal of Finance Wiley

The Resolution of Claims in Financial Distress the Case of Massey Ferguson

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Publisher
Wiley
Copyright
1983 The American Finance Association
ISSN
0022-1082
eISSN
1540-6261
D.O.I.
10.1111/j.1540-6261.1983.tb02258.x
Publisher site
See Article on Publisher Site

Abstract

The Resolution of Claims in Financial Distress the Case of Massey Ferguson CARLISS Y. BALDWIN and SCOTT P. MASON* WHEN A FIRM’S BUSINESS DETERIORATES to the point where it Cannot meet its financial obligations, the firm is said to have entered the state of ‘financial distress’. 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.’ The behavior of firms in financial distress is interesting for two reasons. First the ‘costs of financial distress’ 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

Journal

The Journal of FinanceWiley

Published: May 1, 1983

References

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