Liquidation Costs and Capital Structure

Posted: 20 Dec 1998

See all articles by Michael J. Alderson

Michael J. Alderson

Saint Louis University - Richard A. Chaifetz School of Business

Brian L. Betker

Saint Louis University

Date Written: August 1994

Abstract

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).

JEL Classification: G32

Suggested Citation

Alderson, Michael J. and Betker, Brian L., Liquidation Costs and Capital Structure (August 1994 ). Available at SSRN: https://ssrn.com/abstract=5627

Michael J. Alderson

Saint Louis University - Richard A. Chaifetz School of Business ( email )

3674 Lindell Blvd
St. Louis, MO 63108-3397
United States
314-977-8169 (Phone)
314-977-3897 (Fax)

Brian L. Betker (Contact Author)

Saint Louis University ( email )

St. Louis, MO 63108-3397
United States

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