Michael J. Alderson

Liquidation Costs and Capital Structure

We examine the relation between liquidation costs and capital structure for 88 firms that reorganized under Chapter 11 of the bankruptcy code. Firms in Chapter 11 must disclose information on post-reorganization financial claims and the estimated going concern and liquidation value of the assets that support them. We thus use a direct estimate of the going concern value that would be lost if the firm liquidated, rather than a proxy for intangible value or liquidation costs. We also observe the selection of entirely new capital structures by established firms, in an environment that reduces the recontracting costs caused by holdouts and hidden information. We find that firms with high liquidation costs use less debt than firms with low liquidation costs. Furthermore, the debt these firms do have is more likely to be public and unsecured. Firms with high liquidation costs are less likely to be constrained by debt covenants that prohibit dividends, restrict capital expenditures and prohibit changes in corporate structure. These firms are also less likely to have to prepay their debt out of excess cash flow. Firms with high liquidation costs are also much more likely to attract new equity capital as part of their reorganization process. We thus provide support for the common predictions of capital structure models that relate liquidation costs to debt ratios, including Myers (1977), Williamson (1988), Harris and Raviv (1990) and Shleifer and Vishny (1992).

Liquidation Costs and Accounting Data

We examine the relation between liquidation costs and proxies for those costs that have been used in prior capital structure studies. Liquidation costs in our sample have a strong negative relation to the fixed-to-total assets ratio, and a strong positive relation to the industry market-to-book assets ratio. The relation between liquidation costs and research and development expense is positive, but weak. The adjusted R-squared values of 10% to 20% indicate that much of the variation in liquidation costs is left unexplained by the accounting variables typically used to proxy these costs.

Assessing Post-Bankruptcy Performance: An Analysis of Reorganized Firms' Cash Flows

We analyze the postbankruptcy cash flows for a sample of firms that emerged from Chapter 11 reorganization between 1983 and 1993. We evaluate the rate of return available to investors who owned all of the debt and equity claims on the firm as it emerged from bankruptcy. On average, this return matches the performance of benchmark portfolios during the five years following emergence. Although postbankruptcy operating margins are poor, the market appears to accurately assess the firms prospects at the time it emerges from bankruptcy. Superior returns are generated by high growth-option firms that invest heavily following emergence from bankruptcy.

Financial Innovations and Excesses Revisited: The Case of Auction Rate Preferred Stock

An unprecedented surge in financial innovation took place during the 1980s. One of these innovations was the creation of a family of securities designed to lower the cost of preferred stock financing by widening the availability of the dividends-received deduction (a provision of the tax code that allows corporations to avoid paying taxes on a portion of the dividends that they receive from other corporations).

Managerial Incentives, Net Debt and Investment Activity in All-Equity Firms

Purpose - The purpose of this paper is to examine the impact of managerial risk exposure on capital structure selection (net debt, or debt minus cash) as well as return on assets, capital expenditures, research and development expenditures and stock price performance. Design/methodology/approach - The paper compares a sample of 123 all-equity firms to a set of matching levered firms selected on the basis of industry, market cap and market-to-book assets. Managerial incentives are measured using the delta and vega of the managers stock and option holdings. Findings - Net debt levels decline as CEO wealth sensitivity to stock price changes (delta) increases. However, the paper finds no differences between the all-equity firms and their levered matching firms in terms of return on assets, capital expenditures, R&D expense, or long run stock price performance. Research limitations/implications - Findings are consistent with the idea that managerial incentives drive net debt decisions even among all-equity firms. However, given that there are no differences between the sample firms and their matched firms in terms of investment or stock price performance, the effect of managerial risk aversion appears to be confined to financial policy. Originality/value - The paper uses modern methods for measuring managerial risk exposure to revisit the literature on all-equity firms, and show that managerial risk exposure affects the net debt decision in these firms.

Managerial Discretion Costs and the Acquisition of Capital: Evidence from Forced Warrant Exercise

Forced warrant exercise should elicit a stock price reaction only in response to inventory adjustments or unanticipated increases in agency costs. We find evidence of both effects. Firms calling warrants for redemption experience negative abnormal returns on the announcement date. Negative returns are concentrated among firms whose characteristics suggest that the call should have been deferred. We find lower announcement returns among inefficient firms with low leverage-firms for which the agency costs of managerial discretion may be high. All else equal, announcement returns are lower among inefficient firms that invested heavily in the year after forced exercise.