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Can investors restrict managerial behavior in distressed firms?

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  • Pryshchepa, Oksana
  • Aretz, Kevin
  • Banerjee, Shantanu

Abstract

In this article, we show that only distressed firms not identified as distressed by creditors are able to transfer wealth from creditors to shareholders. Using the number of years to future bankruptcy as a proxy for genuine distress and measures based on observable firm characteristics as proxies for perceived distress, genuinely distressed firms incorrectly perceived as healthy cut payouts to shareholders more slowly and invest more aggressively as uncertainty increases than correctly identified distressed firms. Consistent with the idea that incorrectly identified distressed firms actively hide their troubles, we show that they tend to follow more aggressive accounting policies and often resort to earnings misstatements. We also show that they are often not restricted by covenants and can borrow further debt capital at affordable rates, suggesting that a lack of monitoring by creditors allows them to transfer wealth to shareholders.

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  • Pryshchepa, Oksana & Aretz, Kevin & Banerjee, Shantanu, 2013. "Can investors restrict managerial behavior in distressed firms?," Journal of Corporate Finance, Elsevier, vol. 23(C), pages 222-239.
  • Handle: RePEc:eee:corfin:v:23:y:2013:i:c:p:222-239
    DOI: 10.1016/j.jcorpfin.2013.08.006
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    More about this item

    Keywords

    Agency conflicts; Financial distress; Firm investment; Expected volatility;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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