Which one of the following statements concerning bankruptcy is correct?
A)An indirect cost of bankruptcy is the loss of key employees.
B)Bondholders have a greater incentive than stockholders to keep a firm from filing for bankruptcy.
C)Bankruptcy is sometimes used as a means to increase payroll costs.
D)The assets of a firm tend to increase in value when a firm is in financial distress.
E)The administrative costs incurred in a bankruptcy are considered indirect bankruptcy costs.

Question

Quizplus · Accepted Answer

When a firm files for bankruptcy, key employees may leave the company due to uncertainty about job security or dissatisfaction with the current management. This leads to an indirect cost of bankruptcy for the company.

Answer: B
 Bondholders have a higher priority claim on the assets of the company than stockholders in the event of bankruptcy. Therefore, they have a greater incentive to keep the firm from filing for bankruptcy and avoid losing their investment.

Answer: None of the statements C, D, and E are correct.
 Statement C is incorrect because bankruptcy is used to reduce expenses, not increase them. Statement D is incorrect because in financial distress, the firm's assets may decrease in value due to a lack of demand or unfavorable market conditions. Statement E is incorrect because administrative costs incurred in a bankruptcy are considered direct bankruptcy costs.

Which One of the Following Statements Concerning Bankruptcy Is Correct