Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

P1: TIX/XYZ P2: ABC

JWBT436-bm JWBT436-Baker February 24, 2011 17:26 Printer Name: Hamilton

470 Answers to Chapter Discussion Questions

depart from firm value maximization toward investment policies that ensure

the continuation of the firm under their control.

3. Lang and Stulz (1992) and Hertzel, Li, Officer, and Rodgers (2008) document

contagion of financial distress within an industry and along the supply chain.

Real wealth effects for shareholders exist at the bankruptcy filing by a rival,

supplier, or customer. These wealth effects are also discernable at the onset of

financial distress, often well in advance of the initial default event.

4. An important firm-level determinant of direct and indirect costs is firm size.

Direct costs include both fixed and variable costs. Thus, while total costs are

higher for larger firms, they are lower as a percentage of firm value. For the

largest of firms, the expectation of “too big to fail” policies lowers at least the

expected costs of financial distress. A history of government intervention (early

railroad bankruptcies, airlines, the U.S. steel and auto industries, and most re-

cently the financial services sector) may result in the expectation of assistance

among the largest firm in distress. Arguments in favor of government interven-

tion include employment considerations and potential contagion of distress to

counter parties. Arguments against intervention include the moral hazard prob-

lem where firms retain the benefit of risky projects that pay off but share