An empirical investigation of the impact of troubled debt restructuring on firms in financial distress

Abstract

The purposes of this study were to extend the body of research relating to the use of multiple discriminant analysis in bakruptcy prediction models, the relationship between bankruptcy and troubled debt restructuring, and the nature of troubled debt restructured (TDR) firms. Also, the effects of troubled debt restructurings on firms in financial distress were examined in detail. A descriptive analysis of a sample of sixty troubled debt restructured (TDR) firms was performed. The types of TDR's each firm employed was looked at. Also, specific ratios and financial statement items were compared with those of bankrupt and nonbankrupt firms. In general, the TDR firms were found to be financially better off than the bankrupt firms and financially worse off than the nonbankrupt firms. This result is what might be expected. However, a couple of interesting results occurred which might not be expected. First, there were thirteen firms in the TDR sample which appear to be financially strong. These firms may be experiencing cash flow problems which is a common event. Second, when working capital was analyzed, it was found that the TDR sample had the lowest working capital of all three samples. Even the bankrupt sample had higher working capital. In fact, the TDR firms experienced negative working capital while both the bankrupt and nonbankrupt samples had positive working capital. This result is important and may indicate that working capital or some measure of funds flow is a key factor in TDR research. A sample of both bankrupt and nonbankrupt firms was used to develop a bankruptcy prediction model. Those firms entering bankruptcy from 1972 to 1981 were matched with nonbankrupt firms on the basis of size, industry type, and year of bankruptcy. The TDR firms were then analyzed through this model. In conclusion, this research project examined sixty TDR firms. Several of them undertook more than one type of restructuring. Both before and after TDR, the TDR firms fell into a bimodal distribution with roughly half of them classifying as bankrupt in each year and the other half classifying as nonbankrupt. From statistical testing, it was shown that these firms were becoming financially weaker prior to TDR. But, after TDR, it can only be concluded that these firms did not continue to worsen financially.