FINANCIAL MANAGEMENT : Bankruptcy and restructuring
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.
The bankruptcy process is one of the legal mechanisms that is the least standardised and homogenised around the world. Virtually all countries have a different system. Depending on the country, the process will be either “creditor (lender) friendly” or “debtor (company) friendly”. But all processes have the same goals, although they might rank differently:
- paying down the liabilities of the firm;
- minimising the disruptive impact on the industry;
- minimising the social impact.
The bankruptcy process can generate two types of inefficiencies:
- allowing restructuring of an inefficient firm that destroys value;
- initiating the liquidation of efficient companies.
Prior to court proceedings, 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, fees, etc.) 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 rider issues).