Anatomy of Financial Distress: An Examination of Junk-Bond Issuers

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This paper examines the events following the onset of financial distress for 102 public junk bond issuers. We find that out-of-court debt relief mainly comes from junk bond - holders; banks almost never forgive principal, though they do defer payments and waive debt covenants. Asset sales are an important means of avoiding Chapter 11 reorganization; however, they may be limited by industry factors. If a company simply restructures its bank debt, but either does not restructure its public debt or does not sell major assets or merge, the company goes bankrupt. The structure of a company's liabilities affects the likelihood that it goes bankrupt; companies whose bank and private debt are secured as well as companies with complex public debt structures are more prone to go bankrupt. Finally, there is no evidence that more profitable distressed companies are more successful in dealing with financial distress; they are not less likely to go bankrupt, sell assets, or reduce capital expenditures.

Published: Quarterly Journal of Economics, Vol. 109, no. 3 (1994): 625-658.

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