Reply to this post with whether you agree or disagree and why. Please provide an
ID: 2771856 • Letter: R
Question
Reply to this post with whether you agree or disagree and why. Please provide answer in two paragraphs, at least and at least one APA reference.
Bankruptcy offers an individual or business a chance to start fresh by forgiving debts that simply can't be paid while offering creditors a chance to obtain some measure of repayment based on what assets are available. Direct bankruptcy costs include fees paid to attorneys, accountants, investment bankers, and other professionals involved in bankruptcy proceedings in addition to other expenses directly tied to bankruptcy filing and administration.
So, as we knew when a firm faces increased costs, it leads to bankruptcy. The costs incurred on the process of bankruptcy are referred as bankruptcy costs. The company finances with debt instead of equity and hence these costs are levied.
Types of Direct Bankruptcy Costs
1-Fees of the bankruptcy attorney
– One needs to hire a bankruptcy attorney in order to handle the case. The attorney will certainly charge high fees for handling the case.
Indirect Bankruptcy Costs
The costs of avoiding a bankruptcy filing incurred by a financially distressed firm are called indirect bankruptcy costs.
2-Fees of filing bankruptcy
- The process of filing bankruptcy are very high. It is one of the major portions of direct bankruptcy costs.
Financial Distress
When a firm is having significant problems in meeting its debt obligations, we say that it is experiencing financial distress
These Direct Bankruptcy Costs affect the firm’s value negatively. As the probability of bankruptcy is increased, there is an increase in the cost of financing too.
Explanation / Answer
Direct costs of bankruptcy:
Direct costs include expenses such as legal, court expense, amount paid to the advisory and creditors time. It has beec estimated that, on an average, direct bankruptcy accounts for approximately 5% of the firm value at the time of filing
Inirect costs of bankruptcy:
Incirect costs are caused due to the threat of the bankruptcy and they are relevant even if the firm never defaults on its obligations
some firms have filed for bankruptcy because of actual or likely litigation-related losses. Is this proper use of the bankruptcy process:
The right to file for bankruptcy is a valuable asset. The financial manager objective is to act in the best interest of the shareholders'.One of the ways to do it is by managing this asset in ways that maximize its value. To the extent that a bankruptcy filing prevents "a race to the courthouse steps," it would seem to be a reasonable use of the process.
"Race to the courthouse" is an informal name used to describe the rule in some jurisdictions that the first conveyance instrument, mortgage, lien or judgment to be filed with the appropriate recorder's office, will have priority and prevail over documents filed subsequently, irrespective of the date of execution of the documents at issue that time constraints on bankruptcy judges alter the outcomes of firms that restructure in busy courts. When caseload falls larger firms are less likely to be reorganized and more likely to either be liquidated or dismissed from court. Smaller firms, meanwhile, are actually slightly more likely to be reorganized and less likely to be liquidated when courts are less busy. These results are consistent with the idea that busy judges optimize their time by spending relatively less time on smaller firms while stretching out the proceedings for larger firms. In support of this idea, I find that larger firms spend less time in court as caseloads decline, relative to smaller firms. In addition, my findings have important implications for the costs of financial distress. As direct evidence of this, I find that banks experience fewer charge-offs as local bankruptcy courts become less busy. This is potentially due to several avenues, including reduced recidivism of dismissed firms, lower likelihood of asset sales, and shorter spells in bankruptcy. While my evidence shows that the costs of financial distress are lower in less-busy bankruptcy courts, the overall welfare implications are less clear. In particular, the fact that more firms are dismissed or liquidated when caseloads decline does not necessarily mean that this is socially optimal, despite the fact that bank charge-offs are lower. In theory, somewhere between the extremes of liquidating all firms or none of them, there is some optimal level of “pro-debtor-ness” for a bankruptcy judge (Aghion, Hart, and Moore 1992; Hart 2000; Bernhardt and Nosal 2004; Gennaioli and Rossi 2010). While several previous papers have argued that the Chapter 11 process is biased towards inefficient continuation of 39 firms (Baird 1986; Weiss and Wruck 1998; LoPucki and Kalin 2001), Morrison (2007) shows that many smaller firms are liquidated and argues that there is no continuation bias. The location of Chapter 11 on this liquidation-continuation spectrum remains an open question due to difficulties in finding clean empirical identification. However, both Chang and Schoar (2013) and Becker and Strömberg (2012) use natural experiments to show that pro-creditor shifts in the interpretation of the bankruptcy code tend to enhance firm value. This evidence suggests that busy bankruptcy courts, which tend to allow more continuation, are likely to reduce overall firm value.39 This paper uses the passage of BAPCPA as an exogenous shock to bankruptcy caseloads. While this identification allows me to make causal estimates of the impact of changes in court caseload, it is important to keep in mind the external validity of the experiment. BAPCPA occurred during relatively good economic times, but typically bankruptcy filings spike during economic recessions, and it is possible that the effects I have identified are either tempered or exacerbated by these poor market conditions. In particular, during recessions distressed firms have less ability to roll over previous debts, obtain DIP financing or sell assets at reasonable (not fire sale) prices—actions which would help these firms avoid bankruptcy or handle longer bankruptcy proceedings. If this is the case, this would likely exacerbate the costs of financial distress due to busy courts. This is true both nationwide and on a more local level. Court caseloads vary more crosssectionally than they do over time. While I have couched most of my results in terms of nationwide economic recessions, it is also true that local economic conditions can be quite different across the United States. Localized economic malaise will have the same impact on caseloads in affected bankruptcy districts as nation-wide recessions will. In terms of bankruptcy caseload, where a case is filed can matter as much as when it is filed.