Question 1

Empirical evidence indicates that for distressed firms, higher pre-distress leverage increases the probability of operational actions (e.g., asset restructuring and employee layoffs) and financial actions (e.g., dividend cuts).This evidence is consistent with the:

Accepted Answer

The disciplinary role of debt suggests that higher leverage can pressure management to take corrective actions, such as operational and financial adjustments, to avoid default and improve firm performance. This is consistent with the empirical evidence that distressed firms with higher pre-distress leverage are more likely to undertake such actions.

Question 2

A spin-off is a

Accepted Answer

A spin-off involves distributing new equity claims on a subsidiary to the parent company's shareholders on a pro-rata basis, allowing the subsidiary to become an independent entity while maintaining the original shareholders' proportional ownership.

Question 3

In a dual-class recapitalization (or 'recap'), a firm

Accepted Answer

In a dual-class recapitalization, a company creates a second class of common stock that typically has limited or no voting rights but may have a preferential claim to dividends or the firm's assets in the event of liquidation. This allows the company's founders or current management to maintain control over the company while raising new capital.

Question 4

When the Federal Reserve Board's open market committee buys T-bills, it is pursuing

Accepted Answer

When the Federal Reserve Board's open market committee buys T-bills, it is injecting money into the economy, which is an action associated with expansionary monetary policy. This policy aims to lower interest rates and increase the money supply, encouraging borrowing and spending.

Question 5

Targeted stock, also known as tracking stock or letter stock, is a class of common stock of a diversified company that is

Accepted Answer

Targeted stock is specifically designed to track the performance of a particular business unit or division within a larger company, allowing investors to invest directly in the performance of that specific segment.

Question 6

According to which hypothesis below, the market generally reacts favorably to an asset sale because such sales promote efficiency by allocating assets to better uses.

Accepted Answer

The efficient deployment hypothesis suggests that the market reacts favorably to an asset sale because it believes the sale will lead to a more efficient allocation of resources. This hypothesis posits that assets are transferred to entities that can utilize them more effectively, thereby enhancing overall economic efficiency.

Question 7

If one firm in a given industry declares bankruptcy, the market may lower the values of other firms in a given industry because the reveals new, negative information about the status of the industry as a whole.This phenomenon is called:

Accepted Answer

The contagion effect refers to the phenomenon where the financial distress or failure of one firm leads to negative repercussions or a decrease in the value of other firms within the same industry, due to perceived shared risks or problems. This is because the bankruptcy might signal broader industry issues that could affect other companies.

Question 8

In a(n) __________, the parent of a multiple-subsidiary firm issues, via an IPO, equity shares for a particular subsidiary, though the parent usually keeps majority ownership of the shares, and thus control of the subsidiary.

Accepted Answer

An equity carve-out occurs when a parent company sells a minority interest of a subsidiary to external investors through an initial public offering (IPO), but retains majority control.

Question 9

Bankruptcy risk plays a role in the propagation of recessions by:

Accepted Answer

Bankruptcy risk leads to a strain on the liquidity positions of both individuals and firms as they attempt to maintain enough liquidity to avoid bankruptcy, especially during economic downturns. This can exacerbate the effects of a recession by reducing spending and investment.

Question 10

Agency costs of managerial discretion are one of the few costs that are not exacerbated when a firm is under financial distress.

Accepted Answer

Agency costs of managerial discretion often increase during financial distress as managers may pursue personal objectives over shareholders' interests, potentially exacerbating the firm's financial difficulties.

Question 11

In an equity carve-out, the parent of a multiple-subsidiary firm issues equity claims against a particular subsidiary via a

Accepted Answer

In an equity carve-out, the parent company issues equity claims against a particular subsidiary through a public offering, allowing the subsidiary to access capital markets directly while the parent company retains control over the subsidiary.

Quiz 17: Financial Distress and Restructuring

Empirical evidence indicates that for distressed firms, higher pre-distress leverage increases the probability of operational actions (e.g., asset restructuring and employee layoffs) and financial actions (e.g., dividend cuts) .This evidence is consistent with the: