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Corporate Debt Crisis: Why Your Investment Plans May Be Derailed by Existing Debts
In the current economic environment, companies face many challenges, and debt problems are particularly prominent. The so-called "debt overhang" refers to an organization that cannot easily obtain new funds because of existing liabilities, even if these new borrowings themselves are a good investment opportunity that can generate a positive net present value (NPV). This case is common among companies facing financial difficulties, especially when their existing liabilities exceed expected earnings.
The excess of debt makes holders reluctant to invest in such projects because most of the proceeds will be captured by creditors.
Such situations involve not only businesses, but also governments and households. In many cases, excessive debt hinders further growth even if a company's assets are still worth more than its liabilities. In this context, a useful concept is what we call the "debt trap". It mainly manifests itself when debtors are unable to borrow more funds, thereby affecting their ability to undertake new investments.
What is debt excess?
Debt excess is not only a vicious reduction in demand, but also manifests itself in situations where debtors can no longer borrow funds. For example, a company may find that it has a new investment project that has a positive net present value, but is unable to raise the funds to implement the project because of its existing liabilities. This phenomenon puts both shareholders and creditors in a dilemma.
Existing creditors are expected to make claims on the proceeds of the new project, which further makes the net present value of the entire investment negative.
How does excess debt affect investment decisions?
In companies facing excess debt, any new profits created will be captured in part by existing creditors. This prevents companies from issuing new subordinated capital because the risk of default is quite high. Worse, additional debt only exacerbates the problem of debt overhang, forcing companies to be unable to pursue projects that even have positive NPV.
The economic impact of excess debt
Not limited to individual companies, the phenomenon of excess debt also has a certain impact on the overall economy. During the financial crisis of 2007-2008, governments bailed out banks to address debt overhang. However, many countries mainly purchased newly issued preferred shares, which may not be able to effectively treat the symptoms of debt excess.
Banks soliciting funding are generally not keen on increasing lending once funds are received, gradually sinking the market deeper into a debt glut.
Solution: Reorganization and Reform
The debt overhang is not an insurmountable problem. A common solution is through bankruptcy reorganization, by which many companies reduce their debt burdens and allow new private shareholders to benefit from a positive return on investment. In this process, the reduction in debt levels can enable companies to regain borrowing capacity and activate investment activities to promote economic recovery.
Conclusion
Generally speaking, excess debt is a phenomenon that requires attention. It not only affects the survival and development of enterprises, but also has a long-term impact on the health and stability of the economy. Whether at the corporate level or the national level, targeted strategic adjustments must be made when facing debt overhang. In such a predicament, whether future investment plans can escape the disruption of existing debt has become a question worth pondering?
