Asset Liquidity, Debt Covenants, and Managerial Discretion in Financial Distress: The Collapse of L.A. Gear

36 Pages Posted: 21 Jun 2001

See all articles by Harry DeAngelo

Harry DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Linda DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Karen H. Wruck

Ohio State University - Fisher College of Business, Department of Finance

Date Written: June 2001

Abstract

A hot growth stock in the 1980s, L.A. Gear's equity fell from $1 billion in market value in 1989 to zero in 1998. For over six years as revenues declined precipitously, management tried a series of radical strategy shifts while subsidizing the firm's large losses through working-capital liquidations. The L.A. Gear case illustrates that asset liquidity (broadly construed, not limited to excess cash) can give managers substantial operating discretion during financial distress. It also shows (i) that debt covenants can be stronger disciplinary mechanisms than requirements to meet cash interest payments, (ii) why debt contracts typically constrain earnings instead of cash flow, (iii) why cash balances are not equivalent to negative debt, and (iv) why debt maturity matters. We find that many firms have highly liquid asset structures, thus their managers have the potential to subsidize losing operations should the need arise.

JEL Classification: D21, G31, G32, G33, G34, G35

Suggested Citation

DeAngelo, Harry and DeAngelo, Linda and Wruck, Karen H., Asset Liquidity, Debt Covenants, and Managerial Discretion in Financial Distress: The Collapse of L.A. Gear (June 2001). Dice Center Working Paper No. 2001-7; and USC Finance & Business Econ. Working Paper No. 01-12. Available at SSRN: https://ssrn.com/abstract=273729 or http://dx.doi.org/10.2139/ssrn.273729

Harry DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-6541 (Phone)
213-740-6650 (Fax)

Linda DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-3868 (Phone)
213-740-6650 (Fax)

Karen H. Wruck (Contact Author)

Ohio State University - Fisher College of Business, Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
614-292-4330 (Phone)
614-292-2418 (Fax)

HOME PAGE: http://https://fisher.osu.edu/people/wruck.1

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