Can Investors Restrict Managerial Behavior in Distressed Firms?

38 Pages Posted: 15 Nov 2013 Last revised: 29 Jan 2014

See all articles by Oksana Pryshchepa

Oksana Pryshchepa

Cardiff University Business School; Lancaster University - Department of Accounting and Finance

Kevin Aretz

Alliance Manchester Business School

Shantanu Banerjee

Lancaster University - Management School

Date Written: July 1, 2013

Abstract

In this article, we show that only distressed firms not identified as distressed by creditors are able to transfer wealth from creditors to shareholders. Using the number of years to future bankruptcy as a proxy for genuine distress and measures based on observable firm characteristics as proxies for perceived distress, genuinely distressed firms incorrectly perceived as healthy cut payouts to shareholders more slowly and invest more aggressively as uncertainty increases than correctly identified distressed firms. Consistent with the idea that incorrectly identified distressed firms actively hide their troubles, we show that they tend to follow more aggressive accounting policies and often resort to earnings misstatements. We also show that they are often not restricted by covenants and can borrow further debt capital at affordable rates, suggesting that a lack of monitoring by creditors allows them to transfer wealth to shareholders.

Keywords: agency conflicts, financial distress, firm investment, expected volatility

JEL Classification: G32, G33

Suggested Citation

Pryshchepa, Oksana and Aretz, Kevin and Banerjee, Shantanu, Can Investors Restrict Managerial Behavior in Distressed Firms? (July 1, 2013). Journal of Corporate Finance, Vol. 23, 2013, Available at SSRN: https://ssrn.com/abstract=2354542

Oksana Pryshchepa (Contact Author)

Cardiff University Business School ( email )

Cardiff CF10 3EU
United Kingdom

HOME PAGE: http://https://www.cardiff.ac.uk/people/view/1700999-pryshchepa-oksana

Lancaster University - Department of Accounting and Finance ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

Kevin Aretz

Alliance Manchester Business School ( email )

Crawford House
Oxford Road
Manchester M13 9PL, Lancashire
United Kingdom
+44(0) 161 275 6368 (Phone)
+44(0) 161 275 4023 (Fax)

HOME PAGE: http://www.kevin-aretz.com

Shantanu Banerjee

Lancaster University - Management School ( email )

Lancaster, Lancashire LA1 4YX
United Kingdom

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