Cost of financial stress

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The term costs of financial stress describes the direct and indirect costs of a company in an economically stressed situation in the area of corporate financing . A simple example of the cost of financial stress is bankruptcy costs . These so-called direct costs include legal costs, payments to an insolvency practitioner, and other payments. However, costs of financial stress can also arise if bankruptcy can be avoided (indirect costs).

Direct costs

The direct cash costs of financial stress include:

  • fees
  • Administrative expenses
  • Expenses for advisory services

Indirect costs

The indirect costs ( opportunity costs ) of financial stress include:

  • the decline in demand associated with the economic situation
  • Increase in production costs due to rising input prices (suppliers and investors alike demand a higher risk premium)
  • The restructuring process and negotiations tie up management performance
  • Loss of economic autonomy in bankruptcy proceedings

Effects

Financial stress in companies can lead to a reduction in management efficiency. Because management is accountable to shareholders, management seeks to maximize the market value of equity . Under financial strain, this goal can contradict the goal of maximizing company value , since creditors are served first in the event of dissolution.

If the company value falls below the value of the company's liabilities, it is in the interests of the shareholders, who now have nothing more to lose, for the company to invest in high-risk projects, so that the probability increases that the company value will again rise above this value. High-risk projects, however, are not in the best interests of creditors as they also increase the likelihood that the company's value will continue to decline and leave them with even less. Since these high-risk projects do not necessarily have a positive net present value , costs can arise from unrealized gains .

Management could also postpone bankruptcy, which would have the same effect as adding risk, or it could pay large dividends to move money from creditors to shareholders.

Indirect costs are also higher capital costs . Short term loans from suppliers or banks are expensive, if available at all.

literature

  • Franz Pehn: Financial Distress and Bankruptcy. Valutation, Reorganization and Restructuring of Distressed Companies. VDM Verlag Dr. Muller Aktiengesellschaft & Co. KG, Saarbrücken 2009, ISBN 978-3-639-12921-2 .
  • Söhnke M. Bartram: Corporate Risk Management. An empirical analysis of the financial exposures of German industrial and trading companies. Uhlenbruch Verlag, Bad Soden 1999, ISBN 3-933207-06-1 ( Risk Management and Financial Controlling 3), ( Also : Koblenz, Wiss. Hochsch. Für Unternehmensführung, Diss., 1998: Financial exposure and risk management of industrial and commercial companies .) .

Individual evidence

  1. ^ Wruck, KH: Financial distress, reorganization, and organizational efficiency , Journal of Financial Economics, 1990, Vol. 27 pp. 419-44