Some Evidence of Financial Distress Costs (Alguna Evidencia Sobre Los Costos De Dificultades Financieras)

22 Pages Posted: 31 Aug 2006

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Patricia Rojas

University of the Andes (Colombia)

Date Written: August 29, 2006


In this work we explore several hypotheses about the effect of leverage upon some financial indexes, such as real growth, payment terms from suppliers and gross and operating margins. We explore if there is statistic evidence on the existence of the influence of the book value leverage level in the financial distress or bankruptcy costs that appear as a consequence of the worsening of those indexes. Four hypotheses were explored with the following dependent variables: gross margin, operating margin, real growth in sales and payment terms from suppliers. In order to estimate the financial distress and bankruptcy costs associated with each dependent variable, semi-log and lineal models were constructed using data panel. The data sample used was composed of 644 firms from the commercial Colombian industry, provided by the Superintendence of Societies of Colombia. We also examined an unbalanced sample of 683 firms with regression analysis. We found that there exists a relationship between book value leverage perceived by the market and the real growth and gross margin. This allows us to explore the possibility to introduce the financial distress costs in the cash flows. The aim of the study is to propose a model that allows the analyst to include this effect in the forecasted financial statements. When this effect is included in the financial statements the free cash flows will be affected and hence the interaction of cash flows, cost of capital (weighted average cost of capital) and firm value calculated with the cash flows will eventually allow determining an optimal capital structure.

Note: Downloadable document is in Spanish.

Keywords: Cash flows, forecasted financial statements, cost of capital, bankruptcy costs, financial distress costs

JEL Classification: D61, G12, G31, G33, H43

Suggested Citation

Velez-Pareja, Ignacio and Rojas, Patricia, Some Evidence of Financial Distress Costs (Alguna Evidencia Sobre Los Costos De Dificultades Financieras) (August 29, 2006). Available at SSRN: or

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
+573112333074 (Phone)


Patricia Rojas

University of the Andes (Colombia) ( email )

Carrera Primera # 18A-12
Bogota, DC D.C. 110311

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