Claimholder conflicts in distressed equity offerings: Evidence from German restructurings

Abstract

When firms encounter financial distress, they typically pursue a going concern by restructuring their assets and liabilities. In recent years, several studies have tried to shed light on how firms respond to financial distress. Common operational responses are changes in organizational strategy [e.g. (1990)], asset divestitures [e.g. (1994)], or replacements of key-executives [e.g. (1989)]. Financial measures typically embrace bank-debt restructurings through workouts or public debt restructurings through exchange offers [e.g. (1990), (2005)]. Perhaps surprisingly, so far only little attention has been devoted to issues of fresh equity as a means to overcome financial distress. The ostensible rarity of distressed equity issues is based on a solid economic rationale. When a firm is financially distressed, it is likely that the liquidation value of its assets is below the face value of its liabilities. In such a setting, the firm’s residual claims are essentially worthless and any infusion of equity solely reduces the riskiness of existing debt claims, thus implying wealth transfers to the firm’s creditors [(1977)]. This so called debt-overhang problem induces strong disincentives for shareholders to provide junior funding even in states where positive NPV investments could be financed

I would like to thank Ralf Elsas, Zacharias Sautner, Felix Treptow and Stefan Wagner for their detailed and thoughtful comments. An earlier version of this chapter was also a conference paper at the 1st International Conference on Accounting and Finance (ICAF), Thessaloniki 2006. Two anonymous referees provided helpful comments