What is Financial Distress?

A situation where a firms operating cash flows are not sufficient to satisfy current obligations and the firm is forced to take corrective action. Financial distress may lead a firm to default on a contract, and it may involve financial restructuring between the firm, its creditors, and its equity investors. Penyebab Kegagalan Perusahaan: Faktor ekonomi = 55,1 % Faktor keuangan = 36,0 % Bencana, terabaikan, penyelewengan = 7,1 % Faktor lain-lain = 1,8 %

Types of Financial Distress

Economic failure = pendapatan perusahaan tidak dapat menutupi biayanya termasuk didalamnya biaya modal Business failure = setiap perusahaan yang menghentikan operasi bisnisnya yang diakibatkan oleh kerugian pada kreditor Technical insolvency = perusahaan tidak mampu memenuhi kewajibannya (current obligation) yang telah jatuh tempo. Insolvency in bankruptcy = terjadi apabila nilai buku dari seluruh hutang melebihi nilai pasar dari asset Legal bankruptcy = perusahaan yang dinyatakan bangkrut secara hukum oleh pengadilan

 Stock-base insolvency; the value of the firms assets is less than the value of the debt. Solvent firm
Debt Assets Equity Assets

Insolvency

Insolvent firm
Debt Equity Debt

Note: the negative equity

Insolvency
Flow-base insolvency occurs when the firms cash flows are insufficient to cover contractually required payments.
$
Cash flow shortfall

Contractual obligations Firm cash flow Insolvency

time

The Largest U.S. Bankruptcies

Firm Texaco Executive Life Insurance Mutual Benefit Life Campeau First Capital Holdings Baldwin United Liabilities ($m) $21,603 14,577 13,500 9,947 9,291 9,000 Bankruptcy Date 1987 1991 1991 1990 1991 1983

Continental Airlines (II)

Lomas Financial Macys

6,200
6,127 5,300

1990
1989 1992

Largest U.S. Bankruptcies

Firm Conseco Inc. Worldcom Inc. Enron Corp. Delta Air Lines Pacific Gas & Electric Co. Liabilities (in $ millions) $56,639.30 45,984.00 31,237.00 28,546.00 25,717.00 Date December 2002 July 2002 December 2001 September 2005 April 2001

What Happens in Financial Distress?

Financial distress does not usually result in the firms death. Firms deal with distress by Selling major assets. Merging with another firm. Reducing capital spending and research and development. Issuing new securities. Negotiating with banks and other creditors. Exchanging debt for equity. Filing (mengajukan) for bankruptcy.

What Happens in Financial Distress

No financial restructuring
49%

Financial distress
51% 47%

Private workout

Financial restructuring
53% 83%

Reorganize and emerge

Legal bankruptcy Chapter 11

7%

Merge with another firm

10%
Source: Karen H. Wruck, Financial Distress: Reorganization and Organizational Efficiency, Journal of Financial Economics 27 (1990), Figure 2. See also Stuart C. Gilson; Kose John, and Larry N.P. Lang, Troubled Debt and Violation of Priority Claims, Journal of Financial Economics 27 (1990).

Liquidation

Responses to Financial Distress

Think of the two sides of the balance sheet. Asset Restructuring: Selling major assets. Merging with another firm. Reducing capital spending and R&D spending. Financial Restructuring: Issuing new securities. Negotiating with banks and other creditors. Exchanging debt for equity. Filing for bankruptcy.

Bankruptcy Liquidation and Reorganization

Firms that cannot meet their obligations have two choices: liquidation or reorganization. Liquidation means termination of the firm as a going concern. It involves selling the assets of the firm The proceeds, net of transactions costs, are distributed to creditors in order of priority. Reorganization is the option of keeping the firm a going concern. Reorganization sometimes involves issuing new securities to replace old ones.

Bankruptcy Liquidation: Priority of Claims

The distribution of the proceeds of liquidation occurs according to the following priority: 1. Administration expenses associated with liquidation. 2. Unsecured claims arising after the filing (pengajuan) of an involuntary bankruptcy petition. 3. Wages earned within 90 days before the filing date, not to exceed $2,000 per claimant. 4. Contributions to employee benefit plans arising with 180 days before the filing date. 5. Consumer claims, not exceeding $900. 6. Tax claims. 7. Secured and unsecured creditors claims. 8. Preferred stockholders claims. 9. Common stockholders claims.

Absolute Priority Rule in Practice

The APR states that senior claims are fully satisfied before junior claims receive anything.

Deviations from APR

Equityholders Expectation: No payout Reality: Payout in 81% of cases Expectation: Full payout after secured creditors Reality: Violation in 78% of cases Expectation: Full payout Reality: Full payout in 92% of cases

Unsecured creditors

Secured creditors

Private Workout or Bankruptcy: Which is Best? Advantages of Bankruptcy

1. New credit is available - "debtor in possession" or "DIP" debt. 2. Discontinued accrual of interest on prebankruptcy unsecured debt. 3. An automatic stay provision (ketetapan/ketentuan yang tetap). 4. Tax advantages. 5. Requires only approval by 1/2 of creditors owning 2/3 of outstanding debt.

Disadvantages of Bankruptcy
1. A long and expensive process. 2. Judges are required to approve major business decisions. 3. Distraction (menyebalkan) to management. 4. Hold out (bertahan) by stockholders.

Private Workout or Bankruptcy: Which Is Best?

Both formal bankruptcy and private workouts involve exchanging new financial claims for old financial claims. Usually, senior debt is replaced with junior debt, and debt is replaced with equity. When they work, private workouts are better than a formal bankruptcy. Complex capital structures and lack of information make private workouts less likely.

Summary and Conclusions

Financial distress is a situation where a firms operating cash flow is not sufficient to cover contractual obligations. Financial restructuring can be accomplished with a private workout or formal bankruptcy.

Corporate bankruptcy involves liquidation and reorganization. An essential feature of the U.S. Bankruptcy code is the absolute priority rule (APR).
A hybrid of a private workout and formal bankruptcy is prepackaged bankruptcy.

Altmans Model
Model ini menerapkan multiple discriminant analysis (MDA) untuk memprediksi kemungkinan terjadinya bangkrut pd perusahaan. Model ini diformulasikan sebagai berikut: Z = 0,012X1 + 0,014X2 + 0,033 X3 + 0,006X4 + 0,999X5 di mana X1 = NWC/TA X2 = Retained Earning/total assets X3 = EBIT/TA X4 = MV of CS and PS/BV of Debts X5 = Sales/TA Jika Z < 1,81 probability of bankruptcy besar 1,81 < Z < 2,99 ignorance area Z > 2,99 kemungkinan terjadinya bangkrut kecil Z = 2,675, kemungkinan bangkrut 50:50

Altmans Model
Contoh: X1 = 690/2000 = 0,345 = 34,5%; 34,5 x 0,012 = 0,414 X2 = 766/2000 = 0,383 = 38,3%; 38,3 x 0,014 = 0,536 X3 = 284/2000 = 0,142 = 14,2%; 14,2 x 0,033 = 0,469 X4 = 50(23)/1064 = 1,081=108%; 108,1x0,006 = 0,649 X5 = 3000/2000= 1,5 1,5 x0,999 = 1,499 Nilai Z score = 3,567 Karena Z score = 3,567 adalah di atas 2,99, maka angka ini menunjukkan kemungkinan perusahaan ini bangkrut untuk masa datang tidak beralasan.

Balance Sheet 2008: Assets

PT A 85,632 878,000 1,716,480 2,680,112 1,197,160 380,120 817,040 3,497,152 PT B 7,282 632,160 1,287,360 1,926,802 1,202,950 263,160 939,790 2,866,592

Cash A/R Inventories Total CA Gross FA Less: Dep. Net FA Total Assets

Equity Balance Sheet 2008: Liabilities and Equity

Accts payable Notes payable Accruals Total CL Long-term debt Common stock Retained earnings Total Equity Total L & E PT A 436,800 300,000 408,000 1,144,800 400,000 1,721,176 231,176 1,952,352 3,497,152 PT B 524,160 636,808 489,600 1,650,568 723,432 460,000 32,592 492,592 2,866,592

Income statement (2008)

Sales COGS Other expenses EBITDA Depr. & Amort. EBIT Interest Exp. EBT Taxes Net income PT A 7,035,600 5,875,992 550,000 609,608 116,960 492,648 70,008 422,640 169,056 253,584
PT B 6,034,000 5,528,000 519,988 (13,988) 116,960 (130,948) 136,012 (266,960) (106,784) (160,176)

Other data
No. of shares EPS DPS Stock price
PT A 250,000 $1.014 $0.220 $12.17 PT B 100,000 -$1.602 $0.110 $2.25